Are you looking for a way to diversify your investment portfolio with real estate? But without the hassle of direct property ownership? A real estate investment trust (REIT) may be a good fit for you!
In this article, we’ll answer all the most frequently asked questions about REITs, including:
- What is a REIT
- How do REITs work?
- What are the pros and cons of investing in REITs?
- How does REIT investing compare to direct real estate ownership?
- Are there any better alternatives to REIT investing?
Here’s what you need to know about investing in REITs.
What is a REIT?
A REIT is a company that owns income-producing real estate, like commercial properties and residential rentals. They operate like a mutual fund: investors can buy shares, which entitles them to a percentage of the profits, paid out as dividends.
By investing in a REIT, you get the benefits of diversifying into real estate without having to acquire or manage properties on your own.
How Does a REIT Work?
A REIT typically owns an entire portfolio of properties. It might focus on a certain property type or a certain geographic region. Or, it might diversify across multiple property types and multiple markets.
REITs can be publicly traded on stock exchanges (available to all investors) or private (available only to certain institutional or accredited investors). Being part of major stock exchanges, publicly traded REITs offer liquidity and transparency, allowing investors easy entry and exit points, unlike direct real estate ownership.
To maintain their status as a REIT, these organizations must distribute at least 90% of their taxable income to shareholders annually as dividends, thus avoiding corporate taxes and reducing the double taxation typically associated with dividends. This makes REITs attractive for investors seeking regular income, as they usually offer high dividend yields alongside the potential for moderate capital appreciation.
Pros and Cons of Investing in REITs
The benefits of investing in REITs include:
- Regular income streams. REITs typically distribute dividends to shareholders quarterly, providing a consistent source of passive income.
- Diversification. Investing in REITs can diversify an investment portfolio geographically and across various sectors of the real estate market, such as residential, commercial, and industrial properties.
- Liquidity. Publicly traded REITs can be bought and sold on major stock exchanges, offering liquidity similar to common stock.
- Accountability. Publicly traded REITs are required by the SEC to submit regular financial reports.
- Higher dividend yields. REITs often offer higher dividend yields than other equities, making them attractive for income-focused investors.
- Professional management. REITs are managed by professionals, allowing investors to participate in real estate investments without directly managing properties.
However, there are a few potential downsides to consider as well:
- Market risk. Like all investments, REITs are susceptible to market volatility and economic downturns.
- Liquidity issues for non-traded REITs. Private REITs offer limited liquidity compared to their publicly traded counterparts, making it difficult to quickly sell shares.
- No tax benefits for investors. Although REITs themselves are exempt from corporate income tax, dividends are taxed at the investor’s ordinary income rate, which can be higher than the capital gains tax rate applied to other investment returns.
- Management fees and operational costs. REIT investors pay management fees and other expenses, which can reduce overall returns.
- Lack of control. Investors have no control over which properties are added to the portfolio or sold off.
- Lack of transparency. When investing in a whole fund, like a REIT, it can be difficult to determine how each asset in the fund is performing. You might not even know which properties are included in a REIT.
REIT Investing vs. Direct Real Estate Ownership
Here are some key differences between investing in a REIT and owning property directly.
Professional Management
REITs are professionally managed by real estate experts. They have systems in place for analyzing, acquiring, operating, and selling properties. They typically have entire teams devoted to specialty areas like property management, maintenance, and property taxes.
Individuals owning income-producing properties must handle all of these tasks personally (or personally hire and oversee professionals to manage each aspect).
Upfront Costs
With REITs, you can buy just a few shares at a time. This gives you an option to invest in real estate on a budget.
Direct ownership, on the other hand, requires a down payment and closing costs. You may also have renovation expenses, easily bringing the upfront investment to $50,000 or more.
Diversification Potential
REITs are automatically diversified across multiple properties. Plus, because the investment minimum is comparatively low, you can diversify your investment further by investing in multiple REITs. This protects you from having any single asset perform below expectations. Even if an entire sector (like office space, for example) takes a hit, residential and industrial holdings could potentially bolster your portfolio.
It is much more difficult to diversify with direct real estate ownership. Each property requires so much upfront funding and ongoing costs that acquiring multiple properties can take years. Even then, you’re not going to get the diversification REITs offer.
Investment Alternatives to REITs
If you want to invest in real estate without buying property, but a REIT doesn’t sound like the right fit for you, consider these alternatives.
- Real estate mutual funds. These funds invest in REIT stocks and direct real estate holdings. They provide diversification across different real estate sectors and geographic areas but are subject to stock market fluctuations.
- Private equity. Private equity funds are privately managed investments that pool capital from accredited or institutional investors to acquire and manage real estate, often focusing on higher-risk, higher-reward opportunities with longer investment horizons. They are similar to private REITs in that they require insider connections and provide less liquidity than publicly traded REITs.
- Real estate crowdfunding. Crowdfunding allows investors to pool their money to invest in real estate projects through online platforms. Unlike REITs, some crowdfunding services offer the ability to choose specific projects (called deal-by-deal investing).
- Real estate syndication. Syndication is a special form of crowdfunding in which the investors join the sponsor as members of the entity that owns the real estate. This stable ownership structure provides legal rights to a share in the profits from the project. Real estate syndication offers multiple benefits over REITs, including deal-by-deal control, tax benefits, and greater transparency.
Real Estate Investing with Gatsby Investment
Gatsby Investment, a real estate syndication company, offers accredited investors a unique opportunity to participate in home flips, multi-family properties, and development projects in the hot Los Angeles real estate market.
With relatively low minimum investments placed in a deal-by-deal offering, you can monitor the progress of each individual project in which you have ownership. This crowdfunding platform allows you to be flexible in both the dollars invested and the type of opportunity you wish to pursue. And their solid track record shows proof of success that other investors have enjoyed with Gatsby.
Explore Gatsby’s investment opportunities, and capitalize on residential real estate investing with greater control, tax benefits, and transparency than you can get with REITs!