REIT Investing 101
A REIT (Real Estate Investment Trust) is a popular investment vehicle for those who want to invest in the real estate market without actually owning property. Recently, many of them have been providing very high dividend payouts due to low interest rates.
Why invest in them? Diversification and dividends. Real estate has proven over time to be a strong alternative to traditional company stock investments for those looking to diversify their investment portfolio. REITs have historically provided very strong dividend yields as well – making them a popular choice amongst dividend seekers.
I’ll discuss who REITs might make sense for and some of the risks involved. But first, a little bit more on exactly what they are…
What is a REIT?
A REIT is a company that invests most of its capital into real estate properties and/or mortgages. The income they make is generated from the rental income on the properties they own or the payments on the mortgages they own.
What makes REITs really unique is that they are required by the government to distribute at least 90% of their earnings in the form of dividends to their investors (many distribute 100%). In exchange, they are not required to pay corporate income taxes on their earnings.
REITs distribute dividends on their income four times each year (once per quarter). The dividend yield is the annual dividends divided by the price per share. If you invested in a REIT that had a dividend yield of 10%, for example, and a share price of $100, you would have received a total of $10 over the course of the year.
Different Types of REITs
There are a number of different types of REITs. Many invest only in the properties themselves, while others invest in mortgage securities. Some invest in both.
REITs also differ in the types of real estate that they specialize in. Their focus could be in office real estate, industrial properties, retail (shopping centers/malls), mortgage, health care facilities, self-storage, etc.
A REITs investment focus should be clearly labeled in their 10K (annual report), which you can locate on their website or in the SEC’s EDGAR search database.
Who are they for?
REITs have historically had very high dividend yields. As such, they are great for re-investing and locking in returns or taking dividend payouts as income. They are a popular investment choice for those looking for high yields to generate income.
They are also popular amongst investors who want to invest in real estate, but simply don’t have the resources or the desire to become landlords.
REITs also provide diversification to a balanced portfolio as their share price movement doesn’t usually swing with the ups and downs of the stock market, much like commodities like gold, silver, and oil.
Risks Involved with REITs
The main risk involved with REITs is that they are traded like stocks, and just like stocks their share price and increase or decrease based on market conditions.
If you are thinking of investing in an individual REIT, you should definitely know what types of properties or mortgages they specialize in and the risks involved in that particular sector.
As I highlighted earlier, a REIT investment focus should be clearly labeled in their 10K (annual report), which you can locate on their website or in the SEC’s EDGAR search database.
One thing to consider right now with mortgage REITs is that they often have very high yields due to mortgage interest rates being so low. Should this change (and it will eventually), these types of REITs would become less profitable and be forced to cut their dividend yields. Their share prices could also decline.
It would be a poor investment strategy to simply go out and search for the REITs with the highest yields and buy them because of their yields without understanding why those yields are so high and what the risks are if present market conditions were to change.
Also, it’s worth noting that income that comes from investing in individual REITs is taxed at your ordinary income tax rate, vs. the present 15% capital gains tax rate.
Where can I Find a REIT to Invest in?
If you want to invest in REITs but really don’t know what to look for, an ETF or index fund is probably a safer bet for you as they invest in a number of REITs to diversify your risk.
On the index fund side, Vanguard (VGSIX) is the clear leader in the category. There are a number of REIT mutual funds, however, their fees are all much higher than VGSIX and the REIT ETF’s.
Make sure to compare the ETF and index fund fees involved. Most REIT funds and ETF’s have very low fees.
If you want to find individual REIT’s to invest in, you can start by looking at the holdings of these index funds and ETF’s to find them. Wikipedia also has a list of popular REIT’s that are publicly traded. Keep in mind that this may be a risky strategy – always do your homework first.
Where can I Buy a REIT?
Simply choose how many shares you’d like to buy and execute the trade. You are charged the standard trading fee that is assessed by your discount broker.