Reits Funds 101: A Beginner's Guide to Investing

Investing in real estate can be a great way to diversify your portfolio and potentially earn passive income, but it can also be a complex and time-consuming process. This is where REITs funds come in – a type of investment that allows you to invest in real estate without directly owning physical properties.

REITs funds are a popular investment option for beginners because they offer a relatively low barrier to entry and a range of benefits. For example, REITs funds often have lower minimum investment requirements compared to direct real estate investments.

One of the key benefits of REITs funds is that they allow you to invest in a diversified portfolio of properties with a single investment. This can help spread out risk and potentially increase returns.

Consider reading: Benefits of Reits

A Real Estate Investment Trust, or REIT, is a security that trades like a stock on the major exchanges and owns—and in most cases operates—income-producing real estate or related assets. REITs are structured as a corporation and are not typically taxed at the entity level, which allows investors to avoid double taxation on dividends.

For another approach, see: Reits vs Real Estate

To qualify as a REIT, a company must meet several requirements set by the Internal Revenue Service (IRS), including investing at least 75% of total assets in real estate, cash, or U.S. Treasurys, and deriving at least 75% of gross income from rent, interest on mortgages that finance real estate, or real estate sales.

Some examples of REITs include Healthpeak Properties Inc., which owns, manages, and develops healthcare real estate, and other publicly traded REITs that are registered with the SEC. These REITs offer investors high dividend yields, as well as a liquid method of investing in real estate.

REITs must also pay out 90% of their annual taxable income in dividends, which is one of the key characteristics that distinguish them from other types of investments. By doing so, they typically pay out a higher rate of dividends than equities or many fixed income investments.

Here are the key requirements for a company to qualify as a REIT:

REITs operate like mutual funds, but instead of pooling funds for stocks and bonds, they pool capital from investors to buy large real estate portfolios. Congress established REITs in 1960 through an amendment to the Cigar Excise Tax Extension, enabling firms to make real estate assets liquid.

Investors earn returns from REITs in two ways: from dividends or an increase in the value of the REIT's shares. The amount investors have pooled in REITs has risen significantly in the past quarter century, almost exactly tenfold.

REITs invest in all kinds of properties, including apartment complexes, data centers, healthcare facilities, hotels, infrastructure, office buildings, retail centers, self-storage units, timberland, and warehouses.

REITs were established by Congress in 1960 through an amendment to the Cigar Excise Tax Extension.

They operate like mutual funds, but for real estate instead of stocks and bonds. Investors earn returns in two ways: from dividends or an increase in the value of the REIT’s shares.

Central to REITs is that they take the quintessential example of illiquid assets—real estate—and make them liquid.

REITs invest in all kinds of properties, including apartment complexes, data centers, healthcare facilities, hotels, and office buildings.

REITs generate income by leasing space and collecting rent on their real estate, which is then paid out to shareholders in the form of dividends.

Most REITs pay out at least 90% of their taxable income to shareholders, and many pay out 100%. This means that shareholders pay the income taxes on those dividends.

REITs must pay out a significant portion of their profits to shareholders, which is a key aspect of their business model. This ensures that investors receive regular returns on their investment.

mREITs (or mortgage REITs) finance real estate and earn income from the interest on these investments, rather than owning real estate directly. This approach allows them to generate income without the need for direct property ownership.

By law, REITs must pay out 90% or more of their taxable profits to shareholders as dividends. This is a key requirement that sets REITs apart from other types of investments.

For another approach, see: Income Fund

To qualify as a REIT, a company must invest at least 75% of its total assets in real estate. This means that a significant portion of their assets should be tied up in properties, mortgages, or other real estate investments.

A REIT must also derive at least 75% of its gross income from rents, interest on mortgages, or sales of real estate. This is a key requirement to ensure that the company is primarily focused on generating income from real estate investments.

To meet this requirement, a REIT must pay at least 90% of its taxable income in the form of shareholder dividends each year. This ensures that the company is distributing a significant portion of its income to its shareholders.

Here are the key requirements for a company to qualify as a REIT:

By meeting these requirements, a company can qualify as a REIT and take advantage of the tax benefits and other perks that come with this designation.

REITs own a vast array of assets, with a total of over $4 trillion in gross assets across the U.S.

Public REITs specifically own approximately $2.5 trillion in assets.

U.S. listed REITs have an equity market capitalization of more than $1.2 trillion.

REITs collectively own around 580,000 properties across the U.S.

They also own a significant amount of timberland, with an estimated 15 million acres.

REITs invest in a wide variety of property types, including offices, apartment buildings, warehouses, retail centers, medical facilities, data centers, cell towers, infrastructure, and hotels.

Most REITs focus on a specific type of property, but some hold multiple types in their portfolios.

Listed REIT assets are categorized into one of 14 property sectors.

Suggestion: Types of Reits

To invest in a REIT, you'll need to buy shares of the company's stock on a major stock exchange, just like you would with any other publicly traded company.

The minimum investment required to buy shares can vary depending on the REIT and the brokerage firm you use, but it's often around $100.

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You can buy shares directly from the REIT itself, or through a brokerage firm like Fidelity or Vanguard.

To get started, you'll need to open a brokerage account and fund it with money to invest.

You can then use your online brokerage account to buy and sell shares of the REIT's stock.

The stock price of a REIT can fluctuate constantly, just like any other stock, so it's essential to do your research and set a budget before investing.

By spreading your investment across multiple REITs, you can reduce your risk and potentially earn a more stable income.

Some popular REITs to consider include Realty Income and Simon Property Group, which have a history of paying consistent dividends.

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Some REITs offer monthly payments, but it's not a universal feature.

Most REITs pay quarterly, but a few pay annually or semiannually.

Monthly-paying REITs can be attractive to income-focused investors seeking regular cash flow.

The frequency of payments doesn't necessarily indicate higher returns or better financial health for the REIT.

REITs funds offer several benefits, including the potential for higher yield due to their favorable tax structure, and accessibility through national exchanges. This allows investors to easily buy and sell shares, providing considerable liquidity.

One of the key benefits of REITs is diversification, as they tend to follow the real estate cycle, which can last a decade or more, providing a longer-term investment horizon. This can be particularly useful for investors looking to reduce their risk.

REITs can also serve as an effective hedge against rising inflation rates, as many commercial holdings have agreements that allow them to raise rents in tandem with inflation.

Here are some of the key benefits of REITs funds:

However, REITs also come with several risks, including real estate risk, interest rate risk, occupancy rate risk, geographic risk, and business risk. These risks can negatively impact REITs, particularly if there are fluctuations in property value, changes in interest rates, or shifts in geographic demand.

Related reading: What Happens to Reits When Interest Rates Go down

REITs offer several benefits, including the potential for higher yields, accessibility, and diversification. REITs are listed on national exchanges, providing investors with considerable liquidity and access to a portfolio of commercial real estate assets that may not be available to retail investors.

One of the advantages of REITs is their ability to provide a hedge against rising inflation rates. This is because many REITs have agreements that allow them to raise rents in tandem with inflation.

However, REITs also come with risks, such as real estate risk, which includes fluctuations in property value, leasing occupancy, and geographic demand.

Interest rate risk is another significant concern, as real estate is typically very sensitive to changes in interest rates, which can affect property values and occupancy demand.

Here are some of the key risks associated with REITs:

REITs have a unique tax structure that can impact your returns. They're not typically subject to corporate income tax as long as they distribute at least 90% of their taxable income to shareholders as dividends.

A different take: What Is a Tax Managed Fund

Most REIT dividends are taxed as ordinary income, which can result in higher tax bills, especially for investors in higher tax brackets. This is a key consideration when investing in REITs.

Many people hold REITs in tax-advantaged individual retirement accounts (IRAs) or 401(k)s to mitigate these tax impacts. This allows REIT dividends to compound tax-free or tax-deferred.

The Tax Cuts and Jobs Act of 2017 introduced a qualified business income (QBI) deduction with benefits for REIT investors. This deduction allows eligible taxpayers to deduct up to 20% of their qualified REIT dividends.

The QBI deduction, combined with the REIT's tax-advantaged design, creates a potentially beneficial tax situation for many REIT investors. However, it's essential to consult a tax professional to understand how this applies to your specific tax situation.

REITs often use leverage to buy more properties, so it's crucial to examine their debt-to-equity ratios when comparing different REITs.

On a similar theme: Cubesmart Reit

There are several types of REITs, each with its own unique characteristics. Equity REITs make up the majority of the market, accounting for 96% of the market share in 2023.

Equity REITs own and operate income-producing real estate, generating revenues through rent. They are the most common type of REIT and are often simply referred to as REITs.

Mortgage REITs, on the other hand, lend money to real estate owners and operators through mortgages and loans. They earn their income from the net interest margin, which is the spread between the interest they earn on mortgage loans and the cost of funding these loans.

Here's a breakdown of the different types of REITs:

There are three main types of REITs: Equity, Mortgage, and Hybrid. Equity REITs make up the majority of the market, accounting for 96% of market share in 2023.

Equity REITs own and operate income-producing real estate, generating revenue primarily through rent. They are the most common type of REIT, and their holdings include a variety of commercial and residential properties.

Mortgage REITs, on the other hand, lend money to real estate owners and operators directly or indirectly through mortgage-backed securities. Their earnings are generated primarily by the net interest margin, making them sensitive to interest rate increases.

Suggestion: Commercial Mortgage Reits

Hybrid REITs mix strategies from both equity and mortgage REITs, but have largely disappeared since the 2007-2008 financial crisis.

Here's a breakdown of the types of REITs and their market share:

Healthpeak Properties is a REIT that operates in the healthcare facilities industry, offering a 5.53% forward dividend yield. It's 29% undervalued relative to the Morningstar fair value estimate of $30.50.

Healthpeak's strategic decision to dispose of its senior housing assets in 2020 was a smart move, as it allowed the company to reinvest the proceeds into its life science and medical office portfolios. This shift in focus has positioned Healthpeak for long-term success in the industry.

The company's high-quality assets in top markets attract credit-grade tenants, making it a strong player in both the life science and medical office segments. With a 55% contribution to net operating income from medical office, 35% from life science, and 10% from continuing-care retirement communities and other triple-net assets, Healthpeak's diversified portfolio is a significant advantage.

Healthpeak's recent merger with Physicians Realty Trust added 16 million square feet of high-quality medical office buildings to its portfolio, further solidifying its position in the industry. This deal, worth $5 billion, closed in March 2024 and is expected to provide strong tailwinds for the company's growth.

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Sun Communities is a residential REIT that focuses on owning manufactured housing, residential vehicle communities, and marinas. It has grown significantly over the past decade, expanding its portfolio from 136 properties in 2010 to 666 properties today.

The company collects rental income from tenants who own their own manufactured homes, residential vehicles, and boats, but pay Sun for the right to place their homes or park their vehicles in the community. This rental income is consistent through the year for the manufactured housing portfolio and RV properties with annual memberships.

Sun Communities trades 28% below Morningstar's fair value estimate of $172 per share, with a forward dividend yield of 3.02%. The company's portfolio is nearly 50% located in either Florida or Michigan near major bodies of water, making it a desirable destination for second homes and vacation properties.

The sector has benefited from an aging population with a desire to own a second home or have the time to go on regular vacations. This demographic growth has supported rent growth that exceeds both inflation and the average rent growth reported by the multifamily REIT sector.

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Sun Communities' growth is expected to remain solid for the next several years, but it won't match the heights the company achieved over the past decade. The company's transient business declined in 2023, leading to same-store revenue growth decelerating from the 2021 highs, a trend that is expected to continue in 2024.