Investing in commercial real estate is made possible by real estate investment trusts (REITs), which spare investors from having to purchase and manage properties directly.
A REIT: What is it?
Companies that own real estate are known as real estate investment trusts, or REITs. Like stocks, you can purchase REIT shares, and the primary source of income from REITs is dividend income. Malls, hotels, self-storage facilities, apartments, and warehouses are frequently owned by REITs. Like stocks, REITs can be bought through an investment account, sometimes known as a brokerage account.
How Do Real Estate Investment Trusts Operate?
In order to allow private investors to buy equity stakes in major real estate enterprises in the same way that they could own stakes in other businesses, Congress established real estate investment trusts in 1960. This action simplified the process for investors to purchase and sell a diverse real estate portfolio.
The IRS has established rules that REITs must adhere to, which include:
Every year, return at least 90% of taxable revenues as dividends to shareholders. Investor interest in REITs is greatly piqued by this.
At least 75% of total assets should be placed in cash or real estate.
Get at least 75% of your gross revenue from real estate sources, such as sales proceeds, rent from real estate, and interest on mortgages financing the real estate.
possess a minimum of 100 shareholders following the company’s founding year.
possess no more than 50% of the shares that were held by five or fewer people in the second half of the tax year.
Following these regulations spares REITs from corporate taxation, enabling them to finance real estate at a lower cost than non-REIT businesses and to generate higher profits to distribute to investors. This implies that REITs have the potential to increase in size and dividend payments over time.
With REITs, how much can I make?
Examining benchmarks might be useful for comparing possible returns. The largest 500 American companies are included in the S&P 500 index. That’s what the S&P 500 has done when you look at their overall performance. In a similar vein, equity REIT performance is monitored by the FTSE NAREIT All Equity REITs Index. Furthermore, between 1972 and 2019, the S&P returned 10.6% annually while REITs returned 11.8% on average.
That’s not to claim that stocks are inferior to REITs; it’s just one measure to consider. That being said, you would diversify your portfolio and probably reduce risk if you added REITs to your stock holdings.
June 2024 has the best-performing REIT equities.
Here are a few of the best-performing REITs that are publicly traded:
| Symbol | Company | REIT performance (1-year total return) | Share price |
| SLG | SL Green Realty Corp. | 147.46% | $52.97 |
| ILPT | Industrial Logistics Properties Trust | 110.81% | $3.77 |
| AOMR | Angel Oak Mortgage, Inc | 91.97% | $12.47 |
| VNO | Vornado Realty Trust | 82.56% | $24.52 |
| DHC | Diversified Healthcare Trust | 81.78% | $2.43 |
To obtain quick diversity at a reasonable cost, you can also invest in real estate exchange-traded funds (ETFs) and REIT mutual funds rather than buying individual REITs. Top property-focused mutual funds and exchange-traded funds (ETFs) for the past year include the following:
June 2024 is the best month for REIT mutual funds.
| Symbol | Fund name | 1-year return | Expense ratio |
| CSDIX | Cohen & Steers Real Estate Securities | 11.23% | 0.84% |
| JABGX | JHancock Real Estate Securities R6 | 10.31% | 0.81% |
| RRRRX | DWS RREEF Real Estate Securities | 9.01% | 0.62% |
| BRIUX | Baron Real Estate Income | 7.83% | 0.80% |
| AIGYX | abrdn Real Income & Growth | 7.12% | 1.00% |
June 2024: Top-performing REIT ETFs
| Symbol | ETF name | 5-year return | Expense ratio |
| RSPR | Invesco S&P 500 Equal Weight Real Estate ETF | 5.03% | 0.40% |
| XLRE | Real Estate Select Sector SPDR Fund | 4.27% | 0.09% |
| NURE | Nuveen Short-Term REIT ETF | 3.80% | 0.35% |
| USRT | iShares Core U.S. REIT ETF | 3.52% | 0.08% |
| BBRE | JPMorgan BetaBuilders MSCI U.S. REIT ETF | 3.49% | 0.11% |
Three categories of REITs
Based on the investments they hold, REITs can be classified into three main categories: equity, mortgage, and hybrid. Before you invest, it’s critical to understand the features and dangers associated with each type of REIT.
- Equity Real Estate Investment Trusts
Like a landlord, equity REITs take care of all the management responsibilities that come with real estate ownership. They pay the rent, maintain the property, own the underlying real estate, and make additional investments in it.
- Mortgage Real Estate Investment Trusts
Mortgage REITs, or mREITs for short, are not the owners of the underlying real estate, in contrast to equity REITs. Rather, they possess debt securities secured by the real estate. When a household takes out a mortgage on a home, for instance, this kind of REIT may purchase the mortgage from the original lender and gradually collect the monthly payments, earning income from interest. The family, in this case, is the one who owns and manages the property in the interim.
Compared to their equity REIT brethren, mortgage REITs are typically much riskier and have bigger dividend payouts.
- Hybrid Real Estate Investment Trusts
A hybrid REIT combines elements of a mortgage and equity REIT. These companies own and manage real estate holdings in addition to having mortgages secured by commercial real estate in their portfolio. Make sure you read the REIT prospectus to learn about its main objectives.
In order to further clarify the purchasing process, each REIT category can be further subdivided into three types: publicly traded REITs, publicly non-traded REITs, and private REITs.
REITs with public trading
As the name implies, publicly-traded REITs can be bought with a regular brokerage account and are traded on an exchange alongside equities and ETFs. In the US, there are currently over 225 publicly traded REITs [2].
Transparency and higher governance norms are common among publicly traded REITs. Additionally, they provide the most liquid stock, allowing investors to purchase and sell the REIT’s shares with ease and at a far faster pace than they could, say, if they were buying and selling a retail property themselves. These factors lead many investors to exclusively purchase and sell publicly traded REITs.
Non-traded public REITs
Despite not being listed on a market, these REITs are SEC-registered. Alternatively, they can be bought through a broker who engages in publicly listed non-traded offers, like the internet real estate broker Fundrise. Investors can look for REITs based on their listing status using a database that Neriteit maintains online. The Financial Industry Regulatory Authority claims that these REITs are extremely illiquid due to their non-public trading status, frequently for periods of eight years or longer.
Valuing non-traded REITs can also be challenging. The SEC cautions that these REITs frequently do not assess their worth for investors until 18 months following the closing of their offering, which may be years after you have made an investment.
Investors can purchase shares in publicly listed non-traded REITs through a number of online trading platforms, such as Realty Mogul and DiversyFund.
Individual REITs
In addition to being unlisted, which makes it difficult to value and trade them, private REITs are typically exempt from SEC registration requirements. Because of this, private REITs are exempt from several transparency laws, which could make it more difficult to assess their performance. These restrictions increase the risks associated with these REITs and reduce their appeal to many investors. (See FINRA’s helpful caution on private and publicly traded REITs.)
In addition to having considerably higher account minimums—$25,000 or more—to start trading, private REITs and publicly non-traded REITs may also charge steeper fees. As a result, only accredited investors who have been deemed by the SEC to be eligible to participate in complex securities may access private REITs and many non-traded REITs. These investors have either an annual income of at least $200,000 if single or $300,000 if married, or a net worth of $1 million or more (not including the value of their primary property).
According to Nareit, the FTSE NAREIT All Equity REITs index, which gathers information on all publicly traded equity REITs, performed better than the Russell 1000, a stock market index of large-cap equities, over the 20 years that ended in December 2019. Compared to the Russell 1000’s 6.29% yearly total return, the REIT-indexed investments delivered total returns of 11.6%.
REIT experts elucidated
Investing in REITs, particularly those that are publicly listed, has the following benefits:
Steady dividends: REITs regularly offer some of the best dividend yields in the stock market since they are obligated to distribute at least 90% of their annual profits to shareholders as dividends. Because of this, they are favored by investors seeking a reliable source of income. The most dependable REITs have a history of providing long-term, substantial dividend growth.
High returns: As previously mentioned, REITs can yield returns that are higher than those of equity indices, which is another factor making them a desirable choice for portfolio diversification.
Liquidity: Compared to the arduous process of truly purchasing, managing, and selling commercial properties, publicly traded REITs are significantly simpler to buy and sell.
Reduced volatility: Due in part to their higher yields, REITs have a tendency to be less volatile than traditional stocks. The stomach-churning ups and downs of other asset types can be mitigated by REITs. All investments are susceptible to volatility, though.
Cons of REITs are explained
High debt: REITs’ high debt levels are a result of their legal status. They typically rank among the market’s most indebted businesses. Nevertheless, because REITs usually have long-term agreements that produce consistent cash flow, like leases, which guarantee that money will be coming in, investors have grown accustomed to this scenario and can comfortably support their debt payments and dividend payments.
Low growth and capital appreciation: REITs must raise money by issuing new bonds and stock shares in order to expand because they must pay out a large portion of their income as dividends. There are instances when investors are unwilling to purchase them, such as during a recession or financial crisis. Thus, it’s possible that REITs won’t be able to purchase real estate when they want to. The REIT can expand as long as investors are ready to purchase bonds and stocks in it once more.
Tax burden: Unless their REIT investments are maintained in a tax-advantaged account, investors in REITs are still required to pay taxes on any dividends they receive, even though REIT corporations do not pay taxes. (For this reason, REITs and IRAs can work well together.)
Non-traded real estate investment trusts (REITs) can be costly. Accredited investors may only be able to make the first investment in a non-traded REIT, which could cost up to $25,000. In comparison to publicly traded REITs, non-traded REITs could also charge greater fees.
Illiquid (particularly non-traded and private REITs): As mentioned above, non-traded and private REITs might be more difficult to buy and sell than real estate. However, publicly traded REITs are often easier to buy and sell than real estate. To realize possible returns, these REITs need to be held for years.