If you work in commercial real estate, you’ve probably stumbled across the mysterious acronym REIT at some point or another. Ever wonder what REIT stands for and why they’re so important?
Turns out, they’re not so mysterious. Below we break down exactly what REITs are, how they work, and the pros and cons of investing in them.
Like we mentioned above, the commercial real estate industry loves to talk about REITs. But what are they?!
Before we dive in, let’s clear this up: A REIT, also known as a real estate investment trust, refers to a business that finances, runs, or owns real estate that generates profit.
At its core, a REIT is a corporation that owns profit-generating commercial property. REITs are like mutual funds; they sell shares to investors, who receive dividends on the rent payments collected by property management.
See? Not so scary. Now that you understand the working definition of a REIT, let’s get more nitty-gritty and explore how they work and why you should care…
How REITS Work
For starters, it takes a number of criteria to qualify as a REIT.
The U.S. Security and Exchange Commission’s (SEC) list of mandatory qualifications is long and specific, however, there are a few standout items that must be met. These include…
- The company must be managed by a board of directors.
- The company must boast a minimum of 100 shareholders after its first full year as a REIT.
- The company must pay at least 90% of its taxable income in the form of shareholder dividends each year, and 75% of its assets must be in real estate.
For the full list, read more on the SEC’s website here.
Types of REITs
REITs come in three main categories: equity REITs, mortgage REITs, and hybrid REITs.
Equity REITs are the most common type of REIT. Equity REITs invest in and own income-producing commercial real estate property, such as malls or apartments, that can be invested in through portfolios.
These types of REITs are an important component to the U.S. economy. According to Nareit.com, Equity REITs currently own more the $2 trillion in real estate assets in all 50 states—their large footprint makes them an attractive investment for shareholders and CRE professionals.
Next, Mortgage REITs own and invest in commercial property mortgages and mortgage-backed securities.
Sometimes, these types of REITs are referred to as “mREITS.” Simply put, they loan money to commercial property owners and managers, so that they can purchase mortgages or real estate loans.
These types of REITs play a large part in the housing market; Nareit.com reports that “mREITs help finance 1.8 million U.S. homes: across the country.
On the commercial side of things, however, “they provide a simple way to hold an equity investment in the mortgage market with the liquidity and transparency of publicly traded equities.”
And finally, Hybrid REITs are a combination of the both Equity and Mortgage REITs: they invest in both commercial real estate mortgages and actual properties to maximize returns. By dipping into both types of investments, these REITs intend to mitigate risks, as they usually have low volatility and a steady stream of income.
For example, some REITs are dedicated solely to the retail market, like Simon Property Group (SPG). Simon Property Group (SPG) is a premier mall REIT with properties in North America, Asia, and Europe. The company operates five “sub-markets”within the retail sphere, including “regional malls” and “premiere outlet centers.”
Hotel and hospitality are another popular focus for many REITs.
In 2019, lodging and resort REITs were described as “relatively stable with predictable occupancy rates and the ability to change rates very quickly” by Pedro Silva, wealth manager at Provo Financial Services Group in Massachusetts. Given the success of the hospitality market, many REITs, like Chesapeake Lodging Trust (CLT) and Summit Hotel Properties (INN) are catching the eyes of investors.
But not all REITs are as broad. Some focus on more obscure market offerings and niche asset classes.
For example, data center REITs are growing in popularity. As technology expands, more and more commercial real estate professionals are recognizing the value in data center investment and development. Some REITs, like Digital Realty Trust (DLR) and QTS Realty Trust (QTS) are making data centers and cloud-control their entire focus.
As the market changes and asset performance shifts, REITs change too. Whatever you do, research and stay on top of market trends before you invest to maximize returns and mitigate risks.
Investing in REITs
Sold on REITs? There are a number of ways that you can go about investing in them.
The first way to invest is through the U.S. stock exchange. Just like any other public stock, you can purchase REITs by buying shares through a broker.
You can also invest in non-traded public REITs. Just as publicly listed REITs are registered with the Securities and Exchange Commission, non-traded REITs are also registered with the SEC. However, unlike publicly listed REITs, these REITs are not listed and traded on the public stock exchange.
Private REITs can also be bought. In comparison to public REITs, private REITs are not registered on the stock exchange and do not require SEC registration. In addition, sales of these REITs are typically limited to institutional investors with a net worth over one million dollars.
You can also invest your funds in a REIT ETF (Exchange-Traded Fund), which combine your money with the money of other investors in order to buy REIT stocks.
When you invest in a REIT ETF, you gain access to multiple stakes through a single investment. If you’re overwhelmed by the number of REITs on the market (we know—there’s a lot), investing through a REIT ETF presents lower costs and the option to explore different options.
The Benefits of REITS
For investors of any background, REITs are attractive investment for a number of reasons.
To start, REITs take the headache out of purchasing and managing property. Sure, you could certainly actually go and buy a property, but that’s a lot of time, energy and responsibility. With REITs, the everyday stresses of taking care of a property is all taken care of for you by the property management team.
The liquidity REITs offer is another great perk.
Just like stocks and other mutual funds, you can buy and sell REIT shares quickly and easily. They’re straightforward and follow a solid business model that, in a healthy economy, offers some serious returns.
They’re also easy to sell, so in times of economic distress, there are alternative options. Generally, such dynamic flexibility is another attractive reason for investment.
And finally, diversification.
Especially for investors and other individuals who aren’t as seasoned, diversifying your portfolio through REITs can be a great benefit. Rather than putting all your eggs in one basket, REITs are real, tangible investments that can help pad your portfolio in times of uncertainty. Plus, it helps you can also expect to see returns ranging from 2-6% on any REITs you invest in on average.
If you’re looking to lower portfolio risks, generate passive income or just explore other markets, REITs can be an easy and lucrative way to do so.
The Risks of REITS
Nothing in commercial real estate investment is perfect or foolproof.
REIT investing involves a certain level of risk, as they function like stocks. This makes REITs vulnerable to share price volatility based on market trends. Just like stocks, shares, and other endeavors, REITs can have an inconsistent value that can fluctuate depending on the state of the market.
They can also be expensive and come with fees.
Many REITs rely on a fund manager or a dedicated team of people to manage the REIT. So, investors and shareholders are often charged a fee when the share is sold, or when it’s bought (often referred to as an “issuer cost.” Like any fee, these can be pricey. So make sure to do your research before you invest.
It’s also important to note that investing in REITs will leave you with a smaller return on your investments than if you purchased and managed your own commercial real estate investment.
For example, if you purchase office space for $300,000, you will see a greater return on investment than you would if you put down $2,000 on a property owned by a REIT. However, the fact that REITs are generally a less expensive initial investment than purchasing a property can make them a great choice if you are cash-strapped.
How can you mitigate risks? To reiterate what we mentioned before, diversification can help. Risk is best averted by investing in a broad REIT portfolio. So rather than focusing on just one asset class, it might behoove you to select REITs from different sectors of the commercial real estate market.
It also helps to do your homework. Learn about the real estate market, talk with other investors, and find property records.
Reonomy can certainly help with the latter. By aggregating the nation’s largest pool of off-market properties, you can unlock real estate records on any property across the country. So, if you’re not sure of an investment, you can certainly do your due diligence to make a better judgment call.
The Run Down on REITs
Turns out, REITs aren’t so confusing after all.
And, despite the risk involved, REIT investing offers commercial real estate investors several benefits, including the allure of simplicity and a high level of liquidity.
These factors make REITs a popular choice among investors. While purchasing commercial property outright comes with less risk and greater returns on your investment, REITs are a smart choice if you are looking to get into the market and have little cash, or if you would like to diversify your investments.