Today I’m going to talk about REITs ( Real Estate Investment Trusts) what are they, what is the upside and downside of owning a REIT compared to other investments and more specifically real estate.
What exactly are REITs?
REITs is a fantastic way to add diversity and growth to your portfolio. You can generally think about REITs like a mutual fund for real estate.
What a real estate investment trust essentially does is that it collects money from investors who get shares proportional to their investment and then professional managers invest the money in real estate which is usually done in one of 3 ways:
- The REIT simply buys property and rents it out collecting rental income and paying it in the form of dividends to investors
- The REIT develops properties from the ground up and either sell them or rents them out.
- Or they simply buy mortgages from banks and other financial institutions
For a company to be considered a REIT it must meet the following criteria:
- At least 75% of their income has been derived from real estate ( rent, management fees, etc.)
- Must have at least 100 shareholders
- No more than 50% can be owned by 5 or fewer shareholders
- Pay at least 90% of their income as a dividend
This is quite a few criteria just so a company can be considered a REIT so what is the benefit for a company to be considered a REIT.
Once a company qualifies for REIT status its gets an exemption for paying corporate tax on their profits which is a pretty sweet deal for the company as it helps it keep a big part of its profits and in turn reinvest them for faster growth.
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So what benefits does a REIT hold over directly investing in real estate?
First and maybe most important is the low barrier to entry for a real estate purchase one must have at least 10% down payment and has to qualify for a loan, REITs shares are available for as low as 10$.
Therefore investing in real estate investment trust is way more accessible than buying a property.
Secondly, REITs are very well diversified owning at least a few properties this also allows them to get better deals for buying these properties because they are buying in bulk.
The third benefit is that you are getting certain tasks handled by professionals like for example REITs have professional brokers who choose properties and negotiate the deals.
There are professionals who are fixing and handling the maintenance of the property. The legal aspect is also covered by professional lawyers.
This a huge benefit as very few people have such proficient knowledge to handle these tasks with the speed and efficiency of a professional.
One must also consider the liquidity of REIT shares. They can be bought and sold as quickly as stocks are this is a huge upside compared to rental properties that may take months to complete the transaction.
And one final reason is the fact that an investor can gain exposure to real estate that he or she wouldn’t normally be able to, some REITs specialize in residential properties, offices, storage spaces, hospitals and many more this offers and investor the unique opportunity to get the benefits of a property which he or she wouldn’t normally be able to.
Also one can invest in real estate in a different city or country without having to physically be there.
You can own a very small percentage from a shopping mall or a million-dollar luxury apartment in downtown Manhattan which would otherwise be out of range for the average investor.
With all that said there are certain drawbacks when investing in REITs compared to directly buying real estate some of these include:
One of the biggest drawbacks is that REIT dividend income is taxed as earned income which can reduce one’s profits significantly especially for the US if you are being taxed in the higher income brackets
The share price doesn’t increase that much in value. REITs’ share price doesn’t go as much in value, for example, a stock price or a two-bedroom apartment.
Generally, the share prices follow the price of real estate but there are instances where they lag behind.
You have no control over your investment. This is as much upside as it is a downside, when buying a property yourself you can decide on everything, what color are the walls what is the brand of the microwave etc.
This can in some instances hinder future profits.
One does not get that much leverage when buying a REIT compared to real estate where you put 10% down and own a 10 times more expensive property.
Overall REITs are an inexpensive way to get exposure to the real estate market to diversify your portfolio.
Due to the low barrier for entry, the best way to find out if REITs are for you is to buy a few shares I would recommend checking out DiversyFund. Check out my post Invest in Real Estate with No Fees: Diversyfund Review.
Of course as all investments REITs are associated with risk and there is no guarantee that you will get a return on your investment.