Real estate can be an expensive and challenging investment to get into. But what if there’s a way to get into the property market without ever having to find, maintain, and buy a single property?
That’s the promise of REITs. If you’ve never heard of this term before, you’re not alone. Today, we will explore this investment vehicle by answering the question: “What is a REIT?” We will also go into a bit of detail about the pros and cons of REITs.
What is a Real Estate Investment Trust (REIT)?
A real estate investment trust, or REIT, is a company that buys and owns real estate properties with income–generating potential on behalf of a group of investors. It pools the money from the investors, which they then use to finance property purchases.
A REIT operates similarly to a mutual fund, but with real estate. They usually have the same liquidity as stocks, unlike owning real estate investments yourself, which is not readily transferable. This aspect of REIT not only makes publicly trading them possible but relatively easy.
A real estate trust allows regular folks to own and profit from real estate, without the risks and hassles that typically come with buying and selling properties. REITs can provide a steady stream of income to investors through dividends and earnings from their portfolio of real estate properties. However, it may not offer much in the way of capital appreciation — unlike stocks, which can offer both.
How REITs Work
REITs are mostly publicly traded, just like a stock , in major exchanges in the United States. So what is REIT stock? Think of it as a share of ownership of the commercial real estate portfolio of a REIT. If you own a share of a REIT, you’re called a shareholder.
REITs are usually composed of commercial properties like hotels, office buildings, apartments, and any other income-generating asset. Some REITs diversify in a wide range of properties. However, most of them focus only on one sector, such as only focusing on retail spaces.
The primary way REITs generate income is through leasing spaces to individuals and businesses. The more shares you have, the more income you generate.
Types of REITs
REITs can generally be divided into two main categories, with a third category combining the two. Grouping REITs in these classifications is based on the nature of their investment holdings.
Equity REIT
The first type, equity REIT, owns the real estate property directly. Because of this, they are akin to landlords. They handle everything that a normal landlord would do: performing upkeep, making repairs, and charging rent. Most REITs are equity-based companies.
Mortgage REIT
The second type is a mortgage REIT, meaning it owns the debt of a mortgaged property and not the property itself. Here, the primary source of income is the interest collected from the monthly payments of this debt. Mortgage REITs are seen as riskier since they’re subject to interest swings, but they may pay out higher dividends overall.
Hybrid REIT
The third type is a hybrid REIT, which, as the name suggests, operates both as an equity and mortgage REIT.
Disadvantages of REITs
Like any investment instrument, REITs have their share of disadvantages. Understanding them is vital to make REITs work for you.
- The first thing you need to know is that you’ll have to shoulder tax payments with dividends coming from a REIT. That’s because the REIT itself doesn’t pay taxes, so they pass it on to you.
- Second, some REITs are illiquid, especially privately traded REITs. It means you have to park your funds in them for longer to realize any meaningful gain.
- Third, they are risky due to massive debt. A REIT’s definition means it takes on outside financing to be able to maintain a sizable portfolio of real estate properties.
- Finally, REITs typically have slow growth compared to some other investment types. Since they pay out a lot of dividends, this may leave little cash for them to buy new properties.
The Risks of REITs
REITs are not without risks, and here are some you need to be aware of:
First of all, rental income may not be as secure as you think. There’s some risk that a lot of the tenants of a REITs property won’t be able to pay rent, especially during financial crises. It can hit equity REITs hard and reduce dividend payments.
You’re also susceptible to economic conditions, especially swinging interest rates. When interest rates rise, REIT share prices can experience a downward trend.
Auction.com
While Auction.com does not sell interest in REITS, if you’re interested in expanding your real estate investments Auction.com is here to help too. We allow you to find great discounted foreclosure home investment opportunities. Our secure system offers a safe place to do all of your transactions. Start your foreclosure search and sign up today!
