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Table of Contents:
Why Would You Want to Invest in a REIT?
The first critical question to address is “why?” With so many investment options out there, why should you go with a REIT?
REITs (Real Estate Investment Trust) allow everyday people to invest in commercial real estate. With REITs, you don’t have to possess excessive wealth to invest in property, such as shopping malls. You can also share in the equity of real estate without having the headache of buying a property outright.
The returns for REITs tend to beat the average stock market total returns by several percentage points year after year while also providing above-average dividends. The investment is one of the highest-performing asset classes in existence.
REITs are a smart choice for anyone who wants immediate income and a long-term opportunity for wealth growth.
How Do REITs Work?
REITs either acquire or develop residential and commercial properties. Once the property is up and running, managers rent the space to tenants.
This rental income helps to supply dividends to investors. Some 90% of a REIT’s taxable income must go to the distribution to shareholders each year. This policy ensures unusually high dividends that beat out the dividends paid by most dividend-paying companies.
A small subset of REITs, approximately 10%, is in mortgages instead of real estate. If you’re looking for an example, think Fannie Mae and Freddie Mac. These REITs felt the profound impact of changes in interest rates (we all know what happened in 2008). The higher the interest rate climbs, the lower the stop prices drop.
However, in some low-interest situations, mortgage REITs will trade at a discount to NAV per share. I’ll explain this metric of how to invest in REITs in more detail later in the piece.
What Types of REITs Exist?
Generally, each REIT specializes in one type of property. Let’s take a look at some of the options.
- Residential – This investment usually consists of apartment complexes. These investments are most profitable in large urban centers where homes are not affordable. These locations force many people to rent, allowing landlords to charge large amounts. Investing in these areas often produces the most substantial profits and dividends.
- Healthcare – This investment can take several forms, including medical offices, hospitals, and senior housing facilities. With an aging American population, this form of REIT will likely continue to grow in popularity and profitability.
- Retail – When investing in retail, REITs may take the form of shopping centers, malls, freestanding stores, or outlets. Nearly 24% of REITs are in the retail industry, making it the most significant investment opportunity.
- Industrial – These generally are factories or warehouses.
- Hotel – Many accommodations get funding from REITs, including everything from luxury resorts to inexpensive motels.
- Self-Storage – This form of REIT is for facilities where people rent small units for short- or long-term storage of belongings.
- Data Centers – Some buildings lease space for data storage through REITs.
There are many reasons you may choose one type of REIT over the other. As you consider how to invest in REITs for your investment portfolio, you must also consider the industry’s susceptibility to risk.
Are REITs Risky?
No investment comes with zero risks. It is critical to understand just how much risk you’re undertaking with any investment. One of the most significant risks associated with REITs is interest-rate risk. When interest rates rise, the prices of REITs tend to diminish.
The risks may also vary depending on the REIT you choose. Some industries are more prone to suffering in a recession than others. For example, healthcare is relatively recession-proof because people still need to go to the doctor no matter what is going on with the economy. However, hotels are much more susceptible to economic pressures because many people will stop traveling if their disposable income becomes depleted.
If you’re choosing specific properties to invest in, consider the stability of the tenants in the property. While this idea applies to any REIT, it may be most relevant to retail REITs. REITs make money off the rent paid by tenants in the property. If the tenant company is unstable and closes, you will lose money. You will always want to be on the lookout for robust anchor tenants. Some durable business types that investors should consider are grocery and home improvement stores. Regardless of what is going on in the world economically, people will still need to buy food and repair their homes.
Non-traded REITs have their own set of risks that include an inability to conduct sufficient research and illiquidity. It can be nearly impossible to find comprehensive information about a REIT not publicly traded. And there often are not as many buyers and sellers for these REITs, making it difficult to move one from the investment. Some of these REITs even block investors from selling for at least seven years. Most investors, especially inexperienced ones, will choose publicly-traded REITs.
If the risk is a significant concern to you, you must carefully monitor interest rates. Look for a field that will likely do well even if a recession happens. You may also want to consider investing in a diversified REIT instead of one specializing in a specific property type. Prioritizing diversification is one of the best methods for how to invest in REITs and one of the easiest ways to mitigate risk.
How Do You Evaluate the Performance of a REIT?
You usually can’t evaluate REITs with the same metrics you would use for other types of organizations. When looking at REITs, you must consider FFO.
FFO stands for funds from operations, which is the basic equivalent of earnings. However, FFO considers property depreciation to come up with a more accurate look at its financial viability.
When assessing a REIT, always look at the FFO’s price to compare a fuller picture of its value to its cost.
Some other metrics that may give a fuller picture of your REIT include cap rate, intrinsic value, net asset value, and interest coverage. Let’s examine some of these values now and their impact on strategizing how to invest in REITs.
The cap rate refers to the market’s current pay rate for real estate. Cap is short for capitalization, which may help you remember what this term means.
If the rate were 5%, that would mean that investors are paying about 20 times (1 divided by 5%) the real estate property’s net operating income.
Another way to look at it would be to think about it in terms of your purchase amount. Let’s say you bought a property for $1,000,000. If estimates put the property profits at $50,000 in its first year, the cap rate would be 5%.
The intrinsic value of a REIT refers to the investor’s perception of its value. Another way of putting it is that it is the price the investor will pay compared to the current market rate.
This value takes both tangible assets and intangible factors into effect. However, the number can vary because not everyone puts the same weight on these two categories.
REITs offer many tangible assets that encourage most investors to value this category more highly. However, it does not mean they should ignore intangible factors. A few examples of these factors include:
- The corporate management team
- Law and regulations
- Regional stability
These items are not the only intangible factors that exist, but they are some of the most prevalent.
A related metric is the margin of safety. This value represents the difference between the current market price and the intrinsic value. The higher the margin of safety, the less risk the investor will assume.
You can also inversely calculate your entry price depending on your level of comfort with risk. This calculation will help you determine what price is acceptable as you consider how to invest in REITs.
Net Asset Value (NAV)
The net asset value (NAV) is another metric used to value a REIT. The NAV takes the REIT’s total assets and subtracts the value of all its liabilities.
Some investors also like to look at the NAV per share. This figure takes the NAV and divides it by the number of common shares outstanding.
This metric compares the earnings of the REIT to the interest owed on debts. Interest coverage is in a ratio.
For example, let’s say it was 6:1. This valuation would mean that the REIT was earning six times more money than required to pay interest on its debts.
The most crucial thing to remember is that you should never look at a single metric and call it a day. Each parameter discussed above, and others too, tell part of the REIT’s whole story. Some REITs may have one metric that is off the charts while another poses a major red flag. You must look at various metrics to get a holistic picture of the quality of the investment.
This process is accurate for all investments, not just REITs. A holistic approach plays a critical factor in how to invest in REITs and is what every investor must always remember.
How Do Taxes Get Assessed on REITs?
The set up of REITs helps you to avoid the double taxation that corporations must undergo.
Dividends from REITs get taxed as regular income. The tax rates can get unreasonably high without preferential dividend tax rates. Most people invest in REITs through tax-deferred or tax-free accounts.
This classification allows them to make excellent retirement accounts. Nearly half of all publicly traded REIT shares are in various retirement accounts.
Related: Real Estate Tax and Rental Property
How Do I Get Started Investing in REITs?
Once you learn everything about how to invest in REITs and understand their functions and risks, you’re ready to invest. There is no single way to go about this. You can shop around several online trading platforms and brokers to find one that best fits your needs.
Never be afraid to ask questions. You worked hard to earn your money, and you deserve to completely understand where and how to invest it.
What Is the Difference Between a Platform and a Brokerage?
Generally, platforms allow investors to manage their investments directly. Brokerages utilize representatives to manage the investments for the investors.
With the popularity and simplicity of the internet, these classifications have become blurred. However, if you need more direct assistance with how to invest in REITs, go with a brokerage instead of using a trading platform.
Online Trading Platforms
The platforms discussed below all make it easy for you to invest in real estate properties. While all three will allow you to invest in REITs easily, Equity Multiple and CrowdStreet both specifically help to trade equity in real estate. They may provide a more comprehensive selection of options in this field.
Resource: Best Crowdfunding Sites for Real Estate
Fundrise allows you to invest in three simple steps.
- First, you must choose an account level depending on how much money you will be investing in.
- Next, you need to pick a strategy that most aligns with your goal.
- You can invest over time with options to add money manually or automatically.
Read the full Fundrise Review
EquityMultiple exists specifically for investing in real estate. It offers three approaches on how to invest in REITs. Your decision on these approaches will depend on your timeline and goals.
- Fund investing works well for people looking for diversification right off the bat. With this strategy, you must invest at least $20,000. Expect to leave the money alone for one and a half to ten years.
- Direct investing involves investing in specific properties. With this strategy, you must build your portfolio by adding one property at a time. You need to invest at least $10,000 to start and leave the money for anywhere from six months to five years.
- Tax-deferred investing offers substantial tax benefits. Investors who have recently acquired significant capital gains, or likely will soon, will find this strategy appealing. Generally, it requires an investment of $40,000 left in the account for five to ten years.
Read the full EquityMultiple Review
CrowdStreet is another investment platform dedicated entirely to real estate investing, specifically commercial real estate. This platform also offers three approaches on how to invest in REITs.
- Funds and vehicles will help investors to create a diverse portfolio immediately.
- Individual deals allow full control of where your money is going, even if it may be more tedious.
- Tailored portfolios curated by CrowdStreet help investors to make the best decisions to meet their goals.
Check out our complete review of CrowdStreet for more information.
Learn More: Real estate crowdfunding – Everything You Need to Know
These brokers offer publicly-traded REITs and REIT mutual funds and ETFs. If you want to learn how to invest in REITs alongside other investment types, start a relationship with an online brokerage to handle all your investing needs.
TD Ameritrade is a brokerage that will help you learn the ropes of how to invest in REITs. They walk you through investing in a variety of products. The brokerage offers everything from standard accounts to accounts tailored explicitly to education or retirement.
TD Ameritrade offers many investment opportunities. It has no hidden fees, trading minimums, or deposit minimums.
E*TRADE will give you all the tips you need to invest even if you’ve never done it before. Their process consists of four simple steps.
- First, you must set your goals.
- Next, you need to open your account.
- Choose the things in which you want to invest.
- Finally, you need to monitor your progress to ensure you stay on track to achieve your goals.
Read More: E*TRADE Review
Learning how to invest in REITs can be daunting, but you should never be afraid to branch out and try something new. There are many talented individuals to assist your endeavors. All the platforms and brokers mentioned will be happy to help you make the most of your REIT investment.
Ultimately, REITs undoubtedly come with risks. However, they are a worthwhile investment for savvy investors looking for passive income with tremendous potential to grow. You need not be a millionaire to invest in real estate. Put your money in a REIT today.
Listen to our podcast on REITs: