An REIT can open real estate investing to new investors
Diversification makes for a healthy portfolio, but selectivity is important. You can’t choose this, that and the other and expect to profit from investments you don’t understand. You need to build on a foundation of research, reviewing your options and scrutinizing the details of each investment opportunity.
REITs, or real estate investment trusts, can be an excellent addition to almost any investor’s portfolio. They have a higher average yield when compared to broader equity markets, providing diversification benefits over time relative to other asset classes — and the advantages of REITs don’t end there.
Moving forward, how do REITs factor into your investment goals for 2019? How are they relevant to your plans, and what else can you hope to gain through including this asset class in your portfolio? We’ll walk you through everything you need to know, exploring the subject of REITs in greater depth.
What Are REITs?
To offer a simple explanation of REITs, they’re companies that own, operate or finance income-producing real estate. They pool investors’ money and purchase, maintain and manage commercial and residential properties, passing the income from tenants along to you in the form of dividends.
You might have hesitated in the past to invest in real estate, aware of the difficulties involved in property management. REITs are effectively a way to test the waters without diving in, getting exposure to real estate without the challenges and responsibilities associated with ownership.
How Do REITs Work?
A company has to meet a set of guidelines devised by Congress to qualify as a real estate investment trust. If they meet the requirements detailed below, they’re exempt from corporate taxes, which means they can pass on more money to shareholders. The conditions are as follows:
- Managed by a board of directors
- Considered a corporation under IRS revenue code
- Derives at least 75 percent of income from real estate
- Invests at least 75 percent of assets in cash, real estate or U.S. Treasuries
- Held by at least 100 shareholders, no fewer than five holding 50 percent of shares
- Has a payout of at least 90 percent of taxable income to shareholders via dividends
- Shows 95 percent of income as passive
It’s essential to remember that while the company is exempt from paying taxes on its earnings, investors like yourself still have to pay taxes on their dividends at the ordinary income tax rates. That said, you can deduct 20 percent of income from pass-through investments, lowering your maximum tax rate on REIT dividends.
What Are the Benefits?
There are multiple types of REIT, and you should assess the individual qualities of each before moving forward. Whether you decide to pursue retail REITs, residential REITs, healthcare or office REITs, you can expect similar benefits when investing in this asset class. One of these benefits is the cycle it follows.
Where the rest of the stock market follows the business cycle, pursuant to the rise and fall of economic production, REITs follow the real estate cycle. The business cycle lasts, on average, four years, and the real estate cycle lasts 18. This means a recession affecting the business cycle has no consequence on REITs.
Furthermore, REITs also enjoy greater protection from inflation. As rates of inflation rise, the rent and prices on apartments and hotel rooms rise, as well, balancing out to provide you with the same level of income from your investments. There’s a general consistency for this asset class which many investors find appealing.
How Are REITs Performing?
For all their hypothetical benefits, you likely want to know how REITs have performed in recent years. We can talk forever about the real estate cycle, inflation and high payouts, but if there isn’t hard evidence to support the value of this asset class, any investor would feel hesitant. Fortunately, the numbers support REITs.
Many investors have already seen the potential of REITs firsthand, and it’s simple to understand why they’ve grown in popularity. That said, you should review all of your available options, as not every REIT is worth the investment. Finding a REIT with a strong cash flow profile at an attractive price is sometimes challenging.
When you’re picking investments, you might generally look for companies that are forward-thinking, have steady growth in earnings, and are actively picking up new businesses opportunities. Whether you’re working with a financial professional or are a savvy investor, explore the REIT’s quarterly reports to dig into their yearly successes. You can’t predict a market, but research can help you get a feel for which investments are reliable ones.
Building Your Investment Portfolio
Real estate investment trusts are a promising investment opportunity, but with all investments, it’s essential to show caution. Now that you have a stronger grasp on REITs and what the asset class entails, you can approach the subject with an informed understanding. To restate an earlier point, a foundation of research is vital.
As you continue to build your portfolio, consider some of what we’ve touched on. You might find REITs are precisely what you need.
Written by: Holly Welles, BOSS contributor
Holly Welles is a real estate writer who covers the latest market trends in everything from residential to commercial spaces. She is the editor behind her own blog, The Estate Update, and curates more advice on Twitter.