Derek Morgan
Derek Morgan
real estate advisor with couple explaining investment options
Derek Morgan
Derek Morgan

    Real Estate Investment Trusts (REITs): An Introduction

    In essence, REITs are companies that own, operate or finance income-producing real estate. Modeled after mutual funds, REITs provide all types of investors the opportunity to own valuable real estate, present the opportunity to access dividend-based income and total returns and help communities grow, thrive, and revitalize.

    The Birth of REITs

    The genesis of REITs goes back to the 1960s when the U.S. Congress established them as a way for average investors to access diversified portfolios of large-scale, income-producing real estate, a domain that previously was accessible only to wealthy individuals and institutions. As of now, REITs have grown globally, with more than 35 countries adopting the REIT approach to real estate investment.

    Types of REITs

    REITs often specialize in distinct real estate sectors. The broad categories include:

    • Equity REITs: The most common type of REITs, Equity REITs own and operate income-producing real estate properties. The revenues are primarily generated from rents, not from reselling properties.

    • Mortgage REITs (mREITs): These REITs lend money directly to real estate owners or invest in existing mortgages or mortgage-backed securities. Their income is generated from the interest earned on the mortgage loans.

    • Hybrid REITs: As the name suggests, these are a blend of equity and mortgage REITs. They both own properties and hold mortgages.

    How Do REITs Work?

    In many ways, a REIT operates like a mutual fund. A trust or a corporation uses the pooled capital of many investors to purchase and manage an income property portfolio, including mortgages and properties. The REIT handles management so individual investors don’t need to play an active role in property maintenance or tenant issues.

    REITs and Dividends

    An important feature of REITs is their requirement to pay a large percentage (at least 90%) of their taxable income back to investors as dividends. This unique feature makes them an attractive option for income-focused investors. Plus, since real estate often performs well during bouts of inflation, REITs can serve as a good hedge against inflation.

    To learn more about keeping more cash in your pocket, take a look at How to File you Tax Exemptions: A Step-by-Step Guide for Property Owners.

    The Upside of Investing in REITs

    Now that we've highlighted the basics of REITs, let's delve into their benefits.

    • Liquidity: Unlike physical real estate investments, REIT shares can be bought and sold on major exchanges, providing more liquidity.

    • Diversification: Because REITs can specialize in a single type of real estate (like apartments, office buildings, malls, or industrial facilities), they can offer sector-specific exposure, aiding in portfolio diversification.

    • Dividends: As stated before, REITs are obligated by law to distribute a large portion of their income to shareholders, which can make them a great source of steady income.

    Potential Drawbacks

    As with any investment, REITs have potential downsides.

    • Market Fluctuations: Like any publicly-traded investment, the value of a REIT can go down, potentially leading to losses.

    • Interest Rate Sensitivity: REITs, particularly mREITs, can be sensitive to changes in interest rates. When rates rise, the costs of borrowing for REITs can increase, putting a squeeze on profits.

    For more information on different types of real estate investments, and managing risks, check out Real Estate Investing 101.

    Conclusion

    REITs can serve as a compelling choice for investors looking to enter the real estate market without the necessity of owning physical properties. They can provide income through dividends, the potential for capital appreciation, and an added layer of diversification to an investment portfolio.

    However, like all investment vehicles, it's essential to understand that REITs also have inherent risks. Therefore, potential investors should always do their homework, research individual REITs, and consider consulting a financial advisor to ensure REITs are an appropriate fit for their overall investment strategy.

    As with any investment, knowledge is power. Hopefully, this introduction serves as a launching pad to further exploration into the dynamic world of REITs.

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