Many people do not know what the letters “REIT” stand for, but Real Estate Investment Trusts can be a hidden treasure in the financial world. They enable investors without huge loads of capital to enter into the often-highly profitable world of commercial real estate.
Another definition of an REIT is “real estate stock,” which is accurate because anyone can buy shares in a publicly traded REIT, and REITs are ordered by law to disperse at least 90% of their profits to their shareholders. Many people are flocking to REITs because they enjoy the idea of real estate ownership without the headache of being a landlord. Others get into the REIT game because it is easy to buy and sell shares, rather than being stuck with a property that no one wants to move into and becomes almost impossible to unload.
REITs come in three varieties: equity, mortgage and hybrid.
- An equity REIT purchases, owns and manages income-producing real estate properties such as malls, office buildings and apartments. These are often considered the best option for long-term investing due to their dividends from rental income and sale of properties.
- A mortgage REIT generates income from interest that it receives on mortgage loans. These REITs do not invest in properties, but in both residential and commercial mortgages. These mortgage REITs are a good speculative investment if interest rates cooperate.
- Hybrid REITs are a combination of the REITs mentioned above, owning property and making loans to real estate operators and owners. They earn money through rent and interest.
- Those that center on a single development project and are established for a set number of years. When the project is concluded, the REIT is liquidated and the shareholders receive the proceeds.
- Closed-end and open-ended REITs. The closed-end variety can only issue shares to the public once unless shareholders approve later issuances. Open-ended REITs can issue new shares and redeem them at any time.
- Those that focus on one geographical area or one type of property. Some REITs zero in on a given metro area, while others center on apartments or factories, for instance.
In summary, here are several features of REITs that make them very attractive to the savvy investor:
- The boards of directors of REITs are comprised of real estate professionals that have a sound reputation in their field. Those boards carefully select their REIT’s investments and management teams. When you invest in an REIT, you are gaining access to the collective wisdom of real estate pros that is far beyond your own.
- REITs offer great profit for their shareholders because the REITs don’t have to pay federal income taxes. That means more earnings for the investors. It should be noted, however, that investors do have to pay taxes on their profit, usually at high rates.
- Due to the lengthy lease periods of many commercial properties, REITs offer a fairly predictable revenue stream over the long term. That stream is not greatly impacted by inflation. Rather, rental incomes adjust to the cost of living, meaning a far smaller chance of devaluation.
Here are a few tips for getting into the REIT game:
- Pay attention to demographic information. Try to discern if an area is growing and prospering, or dwindling and hurting before plunking money down on a REIT built on the economic future of a city in the Rust Belt, for instance.
- Consider investing in more than one mortgage REIT to minimize the risk of having your money tied to a part of the country that might experience a severe downturn. Think of the economic fortunes of Florida over the past decade, for example–from hot property to untouchable rentals.
- Beware of extremely high yields when you invest. REITs might be able to pay these out because they are selling property to generate income, which means less rental income in the future.
- Do research on the management of the REIT that interests you. If it has a personal stake in the company, you are, of course, better off. You also want to check out how the management is compensated; if its compensation is tied to the value of the REIT’s assets, it will have long-term thinking. If, however, its compensation is tied to dividends/current earnings, it will often have short-term profit guiding its strategy.
Finally, if you’re interested in investing in real estate yourself, read our postings on:
- Building wealth from nothing
- Investing in real estate without paying for it
- How to invest in rental real estate
Finally, the absolute best book out there on real estate investing strategy for small investors is William Nickerson’s How I Turned $1,000 into Five Million in Real Estate in My Spare Time. Its a really solid book which can show you how to start off with a duplex and leverage it into large multi unit properties. If you’re serious about investing in real estate, the book will probably help.
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