How can you bet on the real estate market without actually buying a property, you ask?
The answer is REITs. REIT is short for Real Estate Investment Trust. Essentially, these trust funds are designed to reflect the activity of the overall market, as well as certain aspects of the real estate market. This allows you to invest in the real estate market without actually buying a house.How can you bet on the real estate market without actually buying a property, you ask?
What are REITs?
REITs are comparable to mutual funds in the sense that the fund is built up of many individual assets, or in this case, properties. REITs, however, trade on a stock exchange, so that investors of all sizes can partake in the opportunity. These were originally designed to allow smaller scale investors to join in on the investment of real estate markets, including debt and equity.
REITs pay very high dividends, but also have an equity growth component to them. They must keep dividend payout ratios at a level of at least 90% of their taxable income. In addition, they must be comprised of at least 100 shareholders and be managed by a Board of Directors.
What are the different types of REITs?
There are three different kinds you can choose from:
- Equity REIT: This is one of the preferred REIT types. Income is generated from the cash flow of renting the owned properties, as well as the appreciation of the property value over time.
- Mortgage REIT: The function of mortgage REITS is to either buy or create a mortgage or mortgage-backed security (MBS). Their purpose is to serve a financing role in the real estate market. These are negatively linked to the general level of interest rates, making them more volatile than equity REITs. Often these REITs focus on residential or commercial mortgage markets.
- Hybrid REIT: Some REITs incorporate investment activities pertaining to both Equity and Mortgage REITs mentioned above.
Pros of investing in REITs
High Dividend Payouts. This is one of the major benefits of REITs as they are very liquid.
Tax Benefits. Trust funds are exempt from certain taxation so long as they distribute at least 90% of their income as dividends. This is beneficial to shareholders. However, retained earnings are still subject to some level of taxation.
Less Volatility. Compared to other equity stocks, REITs follow the real estate market instead and so they are often less volatile. This is great for if you ever need to reduce the volatility of your overall portfolio.
Offers Benefits of Diversification. Rather than investing in a single property or asset, these trusts are comprised of many assets, providing you with the benefits of diversification within your share.
Relatively High Rate of Return. When considering that 90% of income is paid as dividends, it may seem as though a fixed income investment is more comparable in nature. REITs typically provide greater returns than fixed income assets, giving REITs another benefit.
Hands-off Approach to Real Estate Investing. Think about everything involved in buying and selling a house or property. You can reap the benefits using REITs, but instead only have to buy and sell shares.
Cons of investing in REITs
Exposure to Interest Rates. This is particularly true for mortgage REITs. If interest rates rise, the value of mortgage REITs will fall.
Exposure to Occupancy Rates. Since equity REITs generate cash flow from rental properties, any vacancies result in lost opportunities for income.
Void from Tax Benefits. Some REITs do not offer the mentioned tax benefits depending on the focus of their investments. Be sure to find this out before calculating the benefits into your potential return.
Debt Required for Expansion. Since REITs have to pay out so much of their income in dividends, little is left over to invest in further growth. That said, REITs usually require debt to further expand their operations, which is also prone to interest rate risk.
There are numerous US REITs between the NASDAQ and NYSE covering all sorts of industries, so be sure to find the right one for you.