If you’re looking for an alternative to investing in real estate, take a look at investing in shares of a REIT!
It’s no secret that many people consider real estate a good investment.
The stability and security of owning property and the potential for diversity make it a key asset for many portfolios. But what if you don’t have enough money to buy a house outright? Or maybe you don’t want the responsibility of being a landlord?
In that case, REITs can offer a great alternative to investing directly in real estate.
What are real estate investment trusts or REITs?
A real estate investment trust (REIT) is a type of company that owns, operates and/or finances real estate properties. In turn, they issue shares that allow investors to own a portion of the company, including the buildings.
When you buy shares of a REIT, you can get exposure to the real estate market without worrying about being a landlord or dealing with the day-to-day management of properties.
And because REIT’s shares trade on major exchanges, they can be easily bought and sold. You won’t have to deal with details about the transaction, worry about listing a property or arrange financing for the property.
Types of real estate in a REIT portfolio
REITs can have an underlying portfolio that are apartments, office buildings, warehouses, shopping centers, hotels or a combination of these holdings.
Some REITs own properties only in specific geographic areas, while others may be more diversified across a particular country or even worldwide.
The benefits of investing in a REIT instead of a property
Diversified Holdings
When you invest in a REIT, you get exposure not just to one property but to a whole portfolio of properties. The ability to diversify can help protect you from the risks associated with investing in any one specific property.
Not dealing with being a landlord.
One of the best things about owning shares in a REIT is that you don’t have to deal with being a landlord. You will not have to worry about bringing in new tenants, collecting rent, or maintaining the property. The day-to-day tasks are taken care of by the management of the REIT.
Consistent Dividends
Unlike many other types of investments, REITs must pay out about 90% of their taxable income to shareholders in the form of dividends. A lot of investors love investing in dividend stocks because they can provide steady stream of income, which can be especially helpful in retirement or if you want to generate cash from your investments.
More liquid than buying physical property
REIT shares trade on major exchanges, which makes them much more liquid than buying physical real estate. You can easily buy and sell REITs without worrying about finding a buyer for your property.
Tax Advantages
REITs offer some tax advantages as well. In order to legally qualify as a REIT, the company must pay out a certain percentage of income. Due to the nature of the payout, REIT dividends are taxed at a lower rate than other types of income because they are often taxed favorably in many countries.
The risks of investing in a REIT
No investment comes without risk, and investing in REITs is no different.
Interest rate and market risk
REITs typically tend to borrow money to finance their real estate holdings. Your investment will be sensitive to changes in interest rates. When rates go up, it can eat into the profits generated by the REIT because they can’t pass on the costs to the tenants immediately.
REITs are typically subject to the ups and downs of the stock market. If the market falls, then REITs are likely to fall as well.
Operational risks
All businesses face operational risks, and REITs are no different. These risks include changes in zoning laws, tenant turnover, and natural disasters.
Looking at the quality of the properties the REIT owns, or if they are diverse types of properties, can be a way to mitigate some of these risks.
You don’t own or manage the real estate.
A downside of investing in a REIT is that you don’t own or manage the real estate. You don’t have as much control over what happens to your investment and rely on the management’s expertise to take care of the properties and maximize their value.
Like any other type of investment, the value of your REIT shares can go up or down. And if the REIT manager makes poor decisions, it could hurt the value of your investment.
High debt levels
REITs tend to be low-growth companies because they generate the most revenue (and cash flow) from renting out their properties. And because they are capital intensive (meaning they have to spend a lot of money to buy and maintain their properties), they often have high debt levels.
This debt can help optimize revenues and profits. But if debt levels are too high, the REIT might be vulnerable to changes in the economy out of its control (such as higher interest rates).
Macro Risks
When you invest in a REIT, your investment can be affected by many macroeconomic factors. These include events like changes in the economy, interest rates, inflation and political instability.
What to look for when investing in a REIT?
Like any other type of investment, you should conduct your due diligence if you are looking to invest in a REIT. Looking under the hood of any business you want to invest in is wise.
Regarding REITs, here are a few specific things you should look for when conducting your due diligence.
Size and Diversification
REITs can vary significantly in size. The largest ones may have assets worth tens of billions of dollars, while the smallest ones may only have a few hundred million dollars in assets. It’s crucial to pick a REIT that’s the right size for you. A large REIT may offer more stability and less volatility, especially if invested in different asset types (residential, office, industrial) and locations (large cities versus smaller towns).
One way to measure this is to look at the percentage of a REIT’s portfolio comprised of different property types. For example, suppose a REIT only owns office buildings or only in one location. In that case, it may be more vulnerable to an economic downturn than one with a mix of office buildings, retail space and apartments.
Management Team
It’s also essential to research the management team of any REIT you’re considering investing. Look at their experience in the industry and track record of success. A good management team can make a big difference in the performance of a REIT.
Debt Portfolio
If you are peeking into the balance sheet of a REIT, you may want to check out its debt portfolio. The type of debt, the average interest and when the debt is due can all affect the value of the REIT portfolio. Debt can also indirectly affect the business’s ability to take care of the property.
Administrative Expenses
As a REIT investor, you won’t have to worry about maintaining the properties or the portfolio. However, the management team and staff are expenses for REITs. Looking at other REITs of similar size can help you decide if administrative fees are reasonable for the size of the portfolio.
REITs can help you diversify your portfolio.
If you want to invest in real estate but don’t want to buy physical property, then REITs (real estate investment trusts) can offer a great alternative.
REITs can offer a way to diversify your investment portfolio by saving you the hassle of investing directly in real estate.
Whether you invest in REITs is a personal question. As with any investment, you should consider whether REITs fit your overall investment goals.