Equity REITs (pronounced “reets”) give small investors the chance to get in on big investment opportunities without actually having to own any property.
Every REIT pools money from investors to buy and hold investments somehow related to real estate, sort of the way mutual funds and exchange-traded funds (ETFs) pool money from investors to buy a wide variety of stocks or bonds.
They earn income from various sources, though it’s mainly from rental receipts. Investing in REITs gives you an extra layer of diversification (which means holding many different asset types) if most of your investments are in the stock market (most people’s are, especially retirement portfolios).
Diversification helps reduce the overall risk factor of your portfolio. Plus, REITs often outperform the stock market, especially over long periods of time. That’s because their total return includes a combination of income and growth.
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What is REITs?
Unlike other types of investments, REITs have to follow a unique set of strict requirements to maintain their REIT status. That’s true no matter what type of REIT you choose to invest in (and there are several distinct types) and whether it’s publicly or privately traded.
To qualify as a REIT, the company must have at least one hundred investors. It also has to earn at least 75 percent of its income from real estate, which includes real estate–related sources such as mortgage loans.
At least 75 percent of its assets have to be invested in real estate. But what really matters to investors is that every year, a REIT has to distribute 90 percent of its income directly to shareholders in the form of dividends. If you’re looking for an investment that guarantees cash coming in, REITs by nature satisfy that goal.
According to the National Association of Real Estate Investment Trusts (Nareit), equity REITs hold more than two hundred thousand properties across the United States, and hold real estate assets valued at nearly $2 trillion.
If the company meets all of the qualifications for a REIT, it enjoys special tax status: it doesn’t have to pay any taxes at the company level, which means more cash and higher returns for shareholders. (This is in contrast to the double-taxation issues of corporate stocks, where the corporation has to pay taxes on its income before distributing dividends to shareholders, and then the shareholders have to pay taxes on the dividends they receive, resulting in the same money being taxed twice.)
Different Types of Equity REITs
There are many different types of REITs, but at the top level they’re first divided into public and private, which describes how people invest in them. Publicly traded REITs are traded on the stock exchange, just like regular stocks.
This offers investors more liquidity (meaning they’re easier to sell if you need to cash out). Nonlisted public REITs are available to the public but are not listed or traded on exchanges. Private REITs aren’t available to the general public, so they’re generally only accessible to individual investors through specialized advisors.
The next layer is divided between equity and debt REITs. Debt REITs focus on the loan side of the business, holding mortgages or mortgage-backed securities, so their earnings rely mainly on mortgage interest receipts (we’ll talk more about these in the next section).
Most REITs fall into the equity category (when people talk about REITs, this is usually what they’re referring to), meaning they own, develop, and operate actual real estate assets (like office buildings, malls, and medical centers).
From there, equity REITs are classified mainly by the types of properties they specialize in, and that can be virtually any type of property you can think of: apartment buildings, self-storage facilities, warehouses, marinas, and more.
Retail REITs
REITs holding retail properties make up the biggest segment of equity REITs, coming in at around 17 percent. Some retail REITs hold a variety of property types, others focus on single types such as outlets, malls, or stand-alone stores.
Those stores include everything from high-end department stores to supermarkets to big-box retailers. You can easily buy shares in any of thirty-six publicly traded retail REITs, which offer yields topping 4 percent (on average). Examples of retail REITs include:
- Getty Realty Corp. (GTY), which holds convenience stores and gas stations and has a yield of 4.42 percent
- Four Corners Property Trust (FCPT), which holds more than five hundred restaurants in forty-four states and yields 4.18 percent
- SITE Centers Corp. (SITC), which holds shopping centers in major metropolitan areas around the US and has a yield of 6.40 percent
Residential REITs
A good-sized chunk of REITs (around 14 percent, according to Nareit) focus on residential properties. This category includes things like apartment buildings, single- and multi-family rental properties, student housing, and senior housing (such as retirement communities and senior cohousing properties).
While these REITs may have lower yields than other categories, they tend to have lower risk profiles and high-growth potential (which increases total returns). Examples of residential REITs include:
- AvalonBay Communities (AVB), which holds apartment communities throughout the US and has a yield of 3.15 percent
- American Campus Communities (ACC), which holds student housing communities in the US and yields 4.25 percent
- Equity Lifestyle Properties (ELS), which holds manufactured home communities, campgrounds, and RV resorts in North America and has a yield of 2.19 percent
Healthcare REITs
There are eighteen publicly traded healthcare REITs, and these hold a variety of medical-related properties. While a few hold a broad range of real estate types, most healthcare REITs have a narrow focus, specializing in properties such as hospitals, senior living facilities, and medical office buildings. Average yields in this sector top 5 percent. Examples of publicly traded healthcare REITs include:
- National Health Investors (NHI), which specializes in a variety of senior-related properties such as skilled nursing facilities and memory care facilities and has a yield of 5.01 percent.
- Medical Properties Trust (MPW), which holds properties including women’s and children’s hospitals and community hospitals and yields 5.90 percent.
- Physicians Realty Trust (DOC), which holds strategically located healthcare properties associated with hospitals or physician organizations and yields 5.25 percent.
Other Equity REIT Sectors
If you can imagine a type of property, there’s a REIT that specializes in it. From tropical island resorts to state-of-the-art medical facilities to movie theaters, you can buy shares in any type of property that you want to and get guaranteed cash flow from your investment.
- Lodging REITs (e.g., Hospitality Properties Trust [HPT]), which hold properties such as hotels, resorts, and travel centers.
- Self-storage REITs (e.g., Public Storage [PSA]), which specialize in both owning self-storage facilities and renting storage spaces to customers.
- Office REITs (e.g., Boston Properties [BXP]), which own, operate, and lease space in office buildings.
- Industrial REITs (e.g., PS Business Parks [PSB]), which own and manage properties such as warehouses and distribution centers.
- Data center REITs (e.g., Equinix [EQIX]), which own data centers, properties that store and operate data servers and other computer networking equipment.
- Timberland REITs (e.g., Rayonier [RYN]), which hold forests and other types of real estate dedicated to harvesting timber.
- Specialty REITs, which narrow in on very specific properties such as casinos, cell phone towers, or educational facilities.
How To Invest in Equity REITs
Most equity REITs are bought and sold over national exchanges, just like regular corporate stocks. In fact, more than eighty million Americans invest in REITs, mainly through funds in their retirement accounts (though they may not realize it).
Just like with stocks, you can find up-to-the-minute data and detailed analysis on any publicly traded REIT. You’ll look for information on its listing price, current yields, growth trends, management experience, and underlying asset values; you can find that information simply by doing an online search using the REIT’s name or trading symbol.
Once you choose a REIT to invest in, contact your broker (whether it’s a person or an online trading platform) and buy shares—it’s that easy.
Nonlisted and Private REITs
Nonlisted public and private REITs are sold only through financial advisors rather than over exchanges, and investors have to meet minimum suitability requirements to buy in.
Nonlisted public REITs must still register with the Securities and Exchange Commission and provide regular financial disclosures; private REITs do not. Both come with higher investment minimums than publicly traded REITs.
Nonlisted public REITs typically have minimum buy-ins of $1,000 to $2,500. Private REITs may require minimum investments in the $10,000 to $25,000 range. The fact that these securities don’t trade over a public exchange adds a lot of stability to the investment (share prices don’t move with the whims of the market), but it comes at a price; these long-term investments are not liquid.
Depending on the terms of the REIT, investments are typically locked in by minimum holding periods (often at least a few years) with redemption exit ramps starting after ten years.
Most nonlisted REITs have occasional liquidity events, where they allow investors to redeem a portion of their holdings, but those may not coincide with your cash needs. While there is a secondary market (other investors you could sell to), it’s not as big, and you might not be able to sell for as much as your holdings are actually worth.
Choosing Equity REITs
Once you’re ready to invest in equity REITs, you’ll start by choosing a sector (like healthcare or retail) to help you narrow down the options; after all, there are hundreds to choose from. After that, look at the list of REITs in that niche and do some research.
Which you choose will depend on several factors, including your other holdings, risk tolerance, investment horizon (how long you plan to hold the REIT), and income needs.
Good sources of information about management, performance, and future growth potential include Nareit (www.reit.com ), Morningstar (www.morningstar.com ), and Yahoo! Finance (www.finance.yahoo.com ).
It can help to loop in an experienced advisor to help you sort through the REIT choices, and figure out which would fit best into your overall financial plan.
All of these (and more) are listed on public stock exchanges, making them easy to buy and sell (as long as you have a brokerage account). There are also nonlisted and private REITs that you can access through a financial advisor.
The Pros and Cons of Investing in REITs
There’s a reason REITs are popular among wealthier investors: they offer a lot of benefits with fewer risks than other common investment assets. With a solid history of steady, high returns, constant cash flow, and long-term appreciation potential, REITs make a strong addition to any portfolio.
What makes them even better is their diversification factor, adding a new asset class into typically stock-heavy nest eggs. Of course, like all investments, equity REITs also come with some risks.
Access and Income
The main appeal of REITs is that they give regular people access to big-ticket deals. You can buy into a REIT for $5,000 (and sometimes as little as $500), but you couldn’t take part in a $5 million commercial real estate deal without ten times more cash on hand.
Another key reason investors love REITs: they provide reliable income streams in the form of dividends, usually much higher than income from other fixed-income investments. Plus, because of the way they’re structured, REITs offer steady cash flow even during economic slowdowns.
Investment Risks
REIT share prices are more sensitive to changes in interest rates than some other investment assets (like stocks). When interest rates rise, REIT prices begin to drop.
The opposite holds true too: when rates go down, REIT share prices rise. Just like millions of homeowners took a financial bath when real estate prices dropped dramatically when the housing bubble burst, REIT-held property values plummeted too.
That dragged share prices down and even drove some of the more leveraged REITs (ones with a lot of debt) to the brink of bankruptcy. Also, a REIT that’s carrying a lot of debt could be in financial trouble (just like a person buried in student loans and credit card debt) no matter how many profitable properties it holds.
That’s why it’s important to carefully research any REIT you’re thinking of buying into, the same way you would before buying any other investment. You also have to consider property-specific risks.
For example, a REIT that holds primarily retail properties (like stores, malls, and mini-malls) could be badly affected by retail bankruptcies (think Borders or Toys “R” Us) and mall closures, which are becoming more common due to the increase in e-tailers.
How Do Mortgage REITs Work?
Mortgage REITs invest in the other side of real estate: debt. They either invest in mortgages (through mortgage-backed securities), buy up existing mortgages, or act as direct mortgage lenders. These REITs earn their profits mainly through the interest generated on the loans they hold (directly or indirectly).
Instead of holding a portfolio of properties, mortgage REITs count mortgage loans and mortgage-backed securities among their assets. Rather than rent receipts, mREITs bring in interest income that comes from payments made on the underlying mortgages.
These REITs usually pay higher dividends than equity REITs and also come with more downside risk. Typically, mortgage REITs specialize in either residential or commercial mortgage debt, though a few hold both types.
Some offer direct loans to finance property purchases or development projects. Others buy up existing mortgages, while some invest in agency mortgage-backed securities. Regardless of the type of debt they hold, all of it is backed by physical real estate.
Mortgage REITs fall into two broad categories: commercial and residential. While both involve loans secured by property, they don’t work in quite the same way.
Commercial loans tend to have lower loan-to-value ratios (LTVs) than residential loans and shorter loan terms that end in balloon payments. Residential mortgages come with longer loan terms and higher LTVs.
Debt to Equity
Mortgage REITs are funded by a combination of equity (money from investors) and debt (money the REIT has borrowed) that’s used to purchase the assets they hold. Their main goal: earn more interest on their holdings than they pay on their debt.
That difference (between what they receive and what they pay) is called the “spread,” and it’s how mortgage REITs maintain profits and pay out income to investors. When more of their holdings are financed by debt, that spread will be smaller, eating into investor earnings.
To reduce risk, investors can focus on REITs with less leverage. According to Nareit (www.reit.com), the industry median leverage for mortgage REITs is 4×, meaning holdings are financed by four times more debt than equity. For example, with 4× leverage, a $1,000,000 holding would be backed by $200,000 equity and $800,000 debt; four times more debt than equity.
When Interest Rates Rise
Mortgage REITs tend to take price hits when interest rates rise, and that’s especially true if rates increase quickly and unexpectedly. That’s because their holdings bring in the old, lower rate, and investors want to earn the new higher rates.
Again, this pricing issue really comes into play if you’re trying to sell shares. Often, mortgage REITs in this situation look to increase their overall returns gradually by adding new, higher-rate securities to their portfolios.
That means bigger cash flows and higher returns for investors too. Therefore, holding on to a mortgage REIT and giving it a chance to adapt to interest rate changes can keep investors earning the highest possible returns.
Final Words
As with all investments, higher returns are associated with higher risk levels, so don’t judge REITs based solely on their current yields.