Did you know that you can add real estate to your investment portfolio without buying a house, apartment complex or commercial property?
Investing in real estate used to require enormous wealth. For example, if you were looking to buy a mall, how would you even start raising funds?
REITs allow you to get started with investing in commercial and residential real estate. You could even see double-digit returns without lifting a finger (or hammer).
In this article, I’m going to cover everything you need to know about investing in REITs.
What is a REIT?
A REIT, short for Real Estate Investment Trust, is a company that owns various types of commercial real estate, including offices, shopping malls, and even hotels. And that’s just the tip of the iceberg. REITs can also accommodate warehouses, self-storage facilities, apartment buildings, cell towers, data centers, and even wooded areas.
As mentioned earlier, REITs are a fantastic way to invest in the booming real estate market without paying a down payment, dealing with tenants, or funding upgrades and repairs.
REITs are also a clever way to further diversify your portfolio Stocks, tie up, Investment funds, Crypto and precious metals. If a sector of the Economy is downyou can hedge your bets by owning real estate in the form of a REIT.
Like dividend stocks, REIT investors can make money by both appreciating stock prices and paying dividends. However, I would like to point out that most REITs focus on one type of property. So if a particular sector struggles, the REIT is likely to suffer too.
How do REITs work?
The 1960s marked an era of economic prosperity, and REITs emerged in the first year of the decade. REITs gave the average American the opportunity to own income-generating real estate without having to make large investments.
Thanks to REITs, individual investors could now own real estate just as they owned stocks. The average person can now not only invest in real estate, but also benefit from a diversified portfolio by investing in a wide variety of commercial properties.
How REITs make money
How a REIT makes money depends on what type it is. There are three main categories a REIT can fall into.
- Equity. Most REITs are equity REITs that most people are familiar with when they think of this asset class. A stock REIT owns and operates the properties in its portfolio. This REIT works like a traditional landlord and makes money collecting rental checks from tenants or selling real estate.
- Mortgage. Mortgage REITs don’t own the property. Instead, they make money by making loans and collecting interest on mortgages and other credit vehicles. You can also benefit by purchasing mortgage-backed securities (MBS). As a reminder, mortgage-backed securities are a collection of mortgages that are sold to investors as stocks.
- Hybrid. As the name suggests, hybrid REITs are a combination of equity and mortgage REITs.
Types of REITs
There is a REIT to match for every type of commercial property you can think of. In this guide, I’ll cover five of the most common ones.
Retail REITs include malls, malls, outlets, and freestanding stores. Famous examples include Simon Property Group, the largest shopping center operator in the United States, and Realty Income Corp., which owns properties with anchor businesses like Walgreens and 7-Eleven.
Both still make it, despite a blow to stock prices. Despite this problem, they also pay dividends.
Everyone needs a place to hang their head, so residential REITs tend to be a pretty stable investment. This type of REIT includes apartments, single-family homes, and even student housing.
In general, residential REITs can lose value during a recession, but recover more than ever. This pattern became apparent during the 2008 financial crisis and the corresponding REIT boom in 2009 and 2010.
Healthcare REITs are a bright spot in the market right now, and there are currently 17 of them in the U.S. that could diversify your portfolio. As the baby boomer population ages, needs assisted living, and more and more people are taking care of their health, every aspect of the sector is booming.
The demand for health services is inelastic, which means that demand remains constant even as prices rise. For most, health care is not a choice; It’s a necessity.
So if you want to capitalize on a long-term trend, start your career as a REIT investor in healthcare REITs. They are most likely to offer constant growth and a balanced risk.
I recently saw an article outlining how coronavirus destroyed corporate culture and I tend to agree – at least in the short term. Many companies have closed their doors and countless others have taken over remote working from home.
However, this does not mean that there are not yet any opportunities to invest in profitable office REITs. As you’ve probably guessed, office REITs invest in office space. Some specialize in a particular type of building, while others focus on a particular location. Look for REITs with high tenant occupancy and rental collections.
The REITs hardest hit in 2020 were mortgage REITs. As a reminder, mortgage REITs invest in mortgage and mortgage-backed securities and earn income from the interest on those loans.
There is some good news, however. With the price of mortgage REITs falling so dramatically, they are currently viewed by many as undervalued. And they still pay dividends.
On the bearish side of mortgage REITs is the inevitable spike in interest rates that could potentially slow the housing market, hinder mortgage refinancing and make it more expensive for these REITs to repay their debt.
Since mortgage REITs tend to underperform stock REITs, I recommend doing careful research here before investing.
How do I buy REITs?
Below I’m going to outline the different ways you can invest in REITs, starting with opening a good online broker.
What’s even better is that all of my favorite brokers offer $ 0 commission trading, no minimum accounts, and a handy mobile trading platform so you can keep track of your stocks and do business on the go.
1. Open an online brokerage account
You can buy REITs directly from your brokerage account, and the process is almost the same as buying other stocks.
I recommend three brokerage accounts that are suitable for all levels of investor, from the novice to the day trading warrior.
Robinhoods The intuitive user interface and mobile trading platform make trading REITs child’s play. At a glance, you can see whether your investment has gone up and down since you bought it and view your portfolio as a list.
For now, Robin Hood There is a wide range of REITs to choose from with numerous statistics for each and even analyst ratings expressed as a percentage of purchase. For example, at the time of writing, MFA Financial has a 0% buy recommendation while Starwood Property Trust has a perfect 100% buy recommendation.
Advertiser Disclosure – This advertisement contains information and materials provided by Robinhood Financial LLC and its affiliates (“Robinhood”) and MoneyUnder30, a third party not affiliated with Robinhood. All investments involve risk and past performance of any security or financial product is not a guarantee of future results or returns. Securities offered through Robinhood Financial LLC and Robinhood Securities LLC, which are members of FINRA and SIPC. MoneyUnder30 is not a member of FINRA or SIPC. “
E * TRADE
As the first internet-based trading platform presented to the public, E * TRADE receives top marks for simplifying the trading process.
You don’t even need a lot of money to get started. You can also set up watchlists for REITs and be notified when their price hits a high or low or relevant news is released about the company. This function offers you a first mover advantage.
TD Ameritrade is another great option for investing in REITs. Not only are they one of the oldest brokerage firms (they have been around since the 1970s), but their platform is also great for investors who want a little guidance. TD Ameritrade offers a considerable amount of guidance – including relevant articles, news broadcasts, and analysis.
These kind of things are important when investing in REITs because they are a different type of asset class and you want to be sure that you are investing in them correct REIT. TD Ameritrade also has access to a huge selection of stocks, mutual funds and ETFs. You can also trade over 300 ETFs and over 4,000 mutual funds for free.
2. Publicly traded REIT shares
Publicly traded REITs are bought and sold like stocks on public exchanges. There are currently more than 225 REITs registered with the SEC (Securities and Exchange Commission) in the United States. These are all traded on the major stock exchanges. Because these REITs are traded on exchanges like the NYSE, they are transparent and liquid.
By that I mean you can get a lot of information about them – what’s in their portfolio, how profitable they are, etc.
There is also a lot of trading volume. The high trading volume allows you to get in and out of ownership quickly and easily. This concept is called fluid. Compare this to traditional real estate where you have to sell property to make money and you will see one of the main advantages of publicly traded REIT stocks.
3. Private REITs
Private REITs are not traded on any stock exchange and are not registered with the SEC. Private REITs are not required to disclose the financial details as they are private and not publicly traded. This can be problematic when trying to do your own analysis or when you have no confidence in the fund managers.
Private REITs are also illiquid. Since they are not publicly traded, it can be difficult or impossible to sell and cash out your stocks. In addition, there is no corporate governance, which can easily lead to conflicts of interest and unethical compensation practices.
Most individual investors avoid private REITs. They are usually limited to institutional and accredited investors with high assets who are familiar with this asset class or who know the fund managers very well.
4. Non-traded REITs
Non-traded REITs are registered with the SEC but are not publicly traded. They’re like a balance between public and private REITs, but they’re not intended for short-term, casual investors.
This type of REIT is usually sold through a broker who charges an upfront fee. Depending on the size of the fee compared to your investment, this could potentially wipe out your capital and returns. So proceed carefully.
The benefit of an untradable REIT is that it tends to move independently of the exchange as it is not affiliated with exchanges.
5. Publicly traded REIT funds
Not surprisingly, investing in a publicly traded REIT fund follows the same process as investing in a publicly traded REIT. The only difference is that you get multiple REITs in one fund. Think of this as an improvement in diversification, since an Exchange Traded Fund (REIT) ETF will likely contain a variety of properties instead of a single type of property.
However, a REIT fund is not as diversified as owning multiple stocks across multiple industries because the underlying asset class is still real estate.
6. REIT preference shares
REIT preferred stocks are similar to bonds, but they also have some characteristics of a stock. It pays a cash dividend, but also has a fixed redemption price. The price movements are based on interest rates. The higher the interest rate, the lower the value of the REIT preference shares.
When you invest in REIT preferred stocks, you get an extra layer of protection. This is because dividends for preferred stockholders are cumulative, meaning they will receive deferred dividends before common stockholders are paid out.
How to rate a REIT
Just as you would evaluate a company’s performance before buying any stock, there are several metrics you should look at before investing in a particular REIT.
While there are some similarities in comparing performance, this unique asset class requires a slightly different lens. Here’s what to rate and how to interpret your results:
This number, short for funds from operations, is the REIT equivalent of “earnings”. This is essentially the same as the P / E ratio for stocks, which measures the ratio of price to earnings and helps you determine if the stock is over- or undervalued.
The calculation looks like this:
FFO = GAAP Net Income + Depreciation – Gains on Real Estate Sales
The reason this calculation is different for REITs than it is for traditional stocks is because it adds up the deductions made for depreciation. Unlike a regular business, these investments will generally appreciate in value over time. Therefore, deducting these items as an expense would be an inaccurate representation of performance.
Once you have an FFO, you can calculate the P / FFO (price to FFO) to get a comparison ratio. Look at multiple P / FFO ratios side by side to see if a particular REIT is valued higher or lower than similar funds.
Debt to EBITDA ratio
REITs are known to have high levels of debt. After all, they are buying real estate. However, it’s smart to see how much debt a REIT has relative to earnings. As a rule of thumb, many investors aim for a debt EBITDA of less than 6: 1However, you can be flexible given your investment goals and risk tolerance.
Also known as the cap rate, this number is how much a REIT has paid for real estate in relation to its income. Individual investors may think of this as the cash flow or profit a property generates each year based on occupancy rates, repairs, advertising, property management, etc. In the REIT world, these are essentially the same.
To get an idea of what capitalization rates are appropriate for different types of property in different markets, there is one CBRE’s annual survey published that is very comprehensive and incredibly valuable.
To summarize this discussion and give you something specific, My best advice is to compare trends over time to track a REIT’s performance and compare them to peer REITs investing in similar properties. This gives you plenty of context to make a logical decision about what is a good buy and what to avoid.
The pros and cons of REITs
- Source of income. REITs offer investors a reliable source of income. Since REITs have long-term investments in real estate, it is easier to predict and plan sales and profits.
- Diversification. If you want to diversify your stock portfolio, REITs are a great option. While most of them trade like stocks, technically they are a different asset class and not Always move with stock market trends.
- Many possibilities. With REITs, you can invest in any type of property imaginable. Do you have a passion for shopping malls or data centers? There’s a REIT for that.
- Big dividends. 90% of the annual income must be earmarked for the shareholders. This makes them an extremely desirable way to earn dividends.
- Solid performance. In the past, stock REITs have outperformed the stock market.
- Liquid compared to traditional real estate. In contrast to buying real estate, REITs are liquid. You are not tied to a property. Instead, you can buy and sell REIT stock as you see fit when you have extra cash on hand or need to raise cash for something else.
- Low volatility. REITs have relatively low volatility compared to traditional stocks. The high dividend payouts, long-term holding strategies, and transparency keep the value of REITs more stable than other types of stocks.
- Interest rate risk. REITs are subject to interest rate risk. When interest rates rise, REITs are prone to eroding profits.
- Profitability risk. The risk of defaults and job vacancies can put REITs in a position that makes it difficult to maintain profitability. In the current economic climate, this is a very real risk.
- Limited growth. Since REITs pay out 90% of their profits as dividends, the growth rate is limited. While other dividend-paying stocks distribute 30% to 50% of their earnings and implement growth strategies, REITs don’t have this flexibility.
- Higher taxes. REITs are also taxed at higher rates than qualifying dividends. Expect taxes at your marginal dividend income rate.
Finally – you don’t have to be a millionaire to become a real estate mogul. For many people without wealthy families and silver spoons in their mouths, the FOMO (fear of missing out) was real.
REITs can get you started for less than $ 10 and get an immediate return on investment. And with REITs consistently outperforming the stock market (average annual return of 12% from 1998 to 2018 compared to 10% for the market as a whole), you can build wealth even faster.
The first time you dig deep into REITs, you may be wondering where they have been all of your life. Almost half of all publicly traded REIT stocks are held in retirement accounts, so you may have a REIT in your retirement, 401 (k), or IRA without realizing it.