What the heck is a REIT??

THIS PAGE CONTAINS ONE REFERRAL LINK. PLEASE READ MY DISCLOSURE FOR MORE INFO.

There are many reasons people invest in real estate. Some may believe it’s the fastest way to grow their portfolios. Others want to diversify their investments. Still others might not want to invest in real estate, but end up being “reluctant landlords” when they have to move and can’t sell their house. This is all-too-common with military personnel. In my Real Estate Investing series, I’ll explore different ways to invest in real estate and things to look out for. Some of this I’m already familiar with because I’ve been doing it for awhile. For other things, I’ll be learning alongside you, the readers.

You’ve probably heard that investing in real estate is the fastest way to build wealth. Or the fastest way to lose wealth. Or that it’s really easy…or really hard. When you are hearing these claims, generally people are talking about buying a property (often a single family home) and renting it out to a long-term tenant. But there are other ways to invest in real estate. One of those methods is through a Real Estate Investment Trust, or REIT.

(in my head, I pronounce it REE-t. I have a friend that says RE-it and another that spells it out. No idea who is correct)

What is a REIT?

If a stock is an investment security that allows you to own a portion of a company, and a mutual fund is an investment vehicle that allows you to buy tiny portions of a bunch of stocks all at once, then consider a REIT to be a mutual fund for real estate stocks.

Imagine that a single property is a company. And that property makes money, either by being rented out or through the mortgage. Owning a stock of a company would be like owning one brick of the house. Owning a mutual fund would be like owning a square centimeter of bricks from every house in the neighborhood. That’s basically what a REIT is, except that with a REIT it might be a literal house. REITs invest in real estate and allow you to own fractions of a variety of houses, other properties, or mortgages.

REITs can either be a single trust, or they can be purchased as mutual funds or exchange-traded funds (ETF). I’ll talk more about mutual funds and ETFs in my investing series, but for now just think of it as a bunch of REITs in a bucket.

The types of property owned by a REIT are pretty much anything you can imagine. Houses and apartment buildings, sure, but also hospitals, office buildings, malls, land, you name it. REITs can also invest in mortgages and mortgage securities. Many REITs specialize in a specific type of real estate, such as apartment buildings or retail spaces.

U.S. Securities and Exchange Commission Rules for REITs

Of course, there are rules regarding REITs. To qualify as a REIT, the company must have the bulk of its assets and income connected to real estate investment. It also must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.  In addition, a REIT must:

• Be an entity that would be taxable as a corporation but for its REIT status;
• Be managed by a board of directors or trustees;
• Have shares that are fully transferable;
• Have a minimum of 100 shareholders after its first year as a REIT;
• Have no more than 50 percent of its shares held by five or fewer individuals during the last half of the taxable year;
• Invest at least 75 percent of its total assets in real estate assets and cash;
• Derive at least 75 percent of its gross income from real estate related sources, including rents from real property and interest on mortgages financing real property;
• Derive at least 95 percent of its gross income from such real estate sources and dividends or interest from any source; and
• Have no more than 25 percent of its assets consist of non-qualifying securities or stock in taxable REIT subsidiaries.

You can learn more about how the SEC views REITs here.

How do you invest in REITs?

It’s pretty easy, to be honest. REIT shares are purchased basically the same way you’d buy any stock or fund. If you do all of your investing through a retirement account, you can probably find one amongst the choices there. Or, if you have limited options, maybe the funds available in your retirement account have REITs as part of the portfolio. For you military folk, it looks like REITs are not an option in the TSP. But if you or your spouse has another type of retirement account, you may be able to find a REIT there.

You can also purchase a REIT through a taxable investment account. The REIT I own is in my Capital One Investing  account (referral link). You could use Capital One Investing, or any of the other brokerage firms.

Why buy a REIT?

If you are interested in investing in real estate but don’t want the hassle of being a landlord, a REIT may be for you. It’s literally as easy as doing a little bit of research, choosing which REIT to buy, and making the purchase. It’s far less hassle than finding a rental property, not to mention renting it out and dealing with tenants (or hiring a property manager to do those things).

Another thing to consider is how owning a REIT can diversify your investments. If the stock market is on a tear, it might seem like a waste to put money into real estate. After all, you could be earning so much more purchasing the next Apple stock, right??? Well, maybe, but when the stock market crashes, people still need a place to live. Businesses still need office space. So investing in a REIT might be a way to hedge against a market downturn.

Of course, a REIT isn’t a sure thing. It’s still an investment, and investments come with risk. REITs can and do lose money, just like other investments. And in a really bad recession where businesses are closing, maybe a REIT that owns commercial property wouldn’t be the best choice. But you can’t know that for sure ahead of time. REITs don’t necessarily follow the same return trajectory as other investments, so it may be worth a look.

Another plus (in my mind) is that REITs produce dividends, so you can earn income from them. That’s good if you are looking to create passive income streams. Keep in mind that you will have to pay taxes on the dividend income in accordance with normal dividend rules.

Reasons you shouldn’t buy a REIT

If you are the type of real estate investor who wants to be actively involved with the property, a REIT probably isn’t your jam. I’m sure there is some complicated way for you to figure out the addresses of the properties owned by a REIT, but let’s face it – people who buy REITs aren’t doing it so they can drive by and check out whether the tenant is pulling the weeds. If you want to be able to touch your investment, you should be looking at purchasing rental properties.

Gentle reminder: I am not a personal finance professional nor am I a tax professional. You should always do your own research before making changes to your finances. Talk to a financial professional if you need additional help. Please read my full disclaimer here.

Do you own any REITs? Do you like them?