Real Estate Investment Trust (REIT) Definition – What You Need to Know
February 27, 2019
Whether you are driving through the city and staring at office buildings, through the suburbs and looking at homes and apartments, or in the middle of the country passing endless miles of farmland, real estate is abounding. Today, we are going to think about real estate in a different light – as an investment opportunity.
Real estate can be an important element of a diversified portfolio, potentially reducing volatility and acting as a hedge against inflation. While financing, owning and operating individual properties can be cumbersome and is not for everyone, REITs provide investors access to unique investments such as commercial properties.
Technically speaking, a REIT is a company that owns, operates or finances income-producing real estate and is required to distribute at least 90% of its taxable income to shareholders. There are two main types: Equity REITs and mortgage REITs. Equity REITs buy, sell, build, renovate, and manage properties, generating their income mostly from rents collected. They invest in offices, industrial, retail, apartment complexes, hotel and resorts, and even single-family homes. On the other hand, mortgage REITs invest in mortgages or mortgage securities tied to commercial or residential properties or both. They provide financing for income-producing real estate by buying or originating mortgages and mortgage-backed securities. Their income comes from the interest on the investments they make.
Many REITs are publicly traded and are relatively liquid, meaning it is easy for investors to increase or reduce their exposure to real estate. REIT investors can choose among a wide range of sectors and typically earn dividends on their investments and they require smaller capital outlays than direct investments in real estate.
Another point is that the Tax Cuts and Jobs Act of 2017 did allow a noteworthy advantage for REITs— investors can deduct 20 percent of income from REITs and other pass-through investments, lowering the maximum tax rate on REIT dividends from 37 percent to 29.6 percent.
A possible disadvantage to consider is that REITs are interest-rate sensitive. This means that in a rising rate environment, like the one we have experienced over the last six months, share prices for REITs may decline. However, declines may be followed and offset by increases in REIT earnings and dividends.
For sophisticated investors, private or non-traded REITs are still another option and generally, offer higher dividends. Under federal securities law, however, these types of REITs do have suitability requirements.
So, is real estate a good investment? Possibly. Through February, real estate is one of the worst performing asset classes so far in 2018 with the FTSE NAREIT All Equity REIT index (including dividends) down 10%. Could it be a good investment in the future? With expectations of interest rates increasing there is potential for more downside risk in the short term. However, for a long-term investor, real estate could be a good diversifier to a traditional stock and bond portfolio. As always, it is important to speak with your financial advisor to determine if real estate investing is appropriate for your situation.
Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. REIT units/shares fluctuate in value and may be redeemed for more or less than the original amount invested. A nontraded real estate investment trust (REIT) is a REIT that is not traded on any public stock exchange. Nontraded REITs are generally illiquid securities for which no public market exists. As such, investors may be unable to liquidate the security at any price. You should consult with your financial advisor and carefully consider your short-term and long-term liquidity needs. There is no assurance that the investment objective will be attained.
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