Explore REIT (Real Estate Investment Trust) fundamentals: a unique investment vehicle offering income, diversification, & liquidity in real estate markets.

Real Estate Investment Trusts (REITs) are investment vehicles that combine tangible real estate assets with liquid stock market trading. After reading this detailed guide to REITs, you'll have a deep understanding of:

• An overview of REITs
• Types of REITs
• How REITs operate
• Key advantages of REITs
• Key risks of REITs

REITs: An Overview

REITS, or Real Estate Investment Trusts, are companies that own, operate or finance real estate across multiple property sectors and
generate regular income and investment returns for investors. REITs provide retail investors with an opportunity to invest in real estate, receive regular dividend income, and offer an alternative to direct property ownership. While REITs can be private or publicly traded, most REITs trade on major stock exchanges such as the New York Stock Exchange. 

Types of REITs

There are several types of REITs:

Equity REITs: Equity REITs are the most common type of REITs. Equity REITS, the majority of which are publicly traded, invest in and own properties, generating income primarily from the rent they charge tenants. This income is then distributed to shareholders as dividends. Investors can invest in publicly-traded REITs by purchasing them on a national stock exchange.

Mortgage REITs (mREITs): Mortgage REITs provide financing by lending money to real estate owners, or they acquire or originate mortgages or mortgage-backed securities. Mortgage REITs earn interest from these lending, acquisition and origination activities.

Hybrid REITs: Hybrid REITs combine the investment strategies of both equity and mortgage REITs, owning properties and holding mortgages. Investors who prefer diversification can get access to both debt and equity may choose to invest in Hybrid REITs.

Private REITs: Private REITs are REITs that aren’t publicly traded on a national stock exchange.

How do REITs Operate?

For a company to qualify as a REIT, it must meet certain requirements and comply with certain regulatory guidelines. For example, there are requirements with respect to income distribution, asset mix, income generation, management and shareholders. For example, a REIT must meet some of the following requirements:

Income Generation: At least 75% of its gross income should come from real estate sources, such as rent.

Asset Holding: At least 75% of the company’s assets should be in real estate, cash or U.S. Treasuries.

Distribution: REITs must return a minimum of 90% of their taxable income to shareholders in the form of dividends.

Management: Like most companies, REITs are managed by a board of directors or trustees.

Shareholders: REITS should have a minimum of 100 shareholders. To avoid concentration, with no five investors owning more than 50% of shares.

REITs: Key Advantages

REITs provide several key advantages for investors, including:

Liquidity: Unlike physical properties, REIT shares can be bought or sold on major stock exchanges, which can provide immediate liquidity for investors.

Diversification: REITs offer an opportunity to diversify an investment portfolio away from traditional equities. 

Stable Dividends: REITs historically have provided high dividend yields combined with long-term capital appreciation.

Ownership: Investors can “own” real estate (and enjoy the associated benefits) without directly having to purchase or operate real estate assets. 

REITs: Key Risks

Despite the clear advantages of REITs, they are subject to risk. For example, interest rate sensitivity, market volatility and cyclical market dynamics all represent potential downside risks to REITs. 

Interest Rates: As interest rates increase, a REIT’s dividend yield may become less attractive. 

Liquidity Risk: While REITs generally are liquid, private REITs generally aren’t traded. As such, investors may struggle to convert their investment to cash.

Market Risk: An overall drop in property prices, oversupply or a drop in
rental income could adversely impact REIT performance.

Tenant Risk: As a landlord, a REIT could lose rental income due to tenant vacancy, loan default or bankruptcy.

Leverage Risk: Since REITs often finance acquisitions with debt, economic downturns could lead to higher loan defaults or financial pressure to repay loans, which could put underlying real estate assets at risk.

Conclusion

REITs offer a compelling opportunity to access real estate investing without the pressure of owning real estate assets directly. With stable dividends, liquidity and income appreciation, REITs are an accessible asset class for retail investors. While not immune from risks, REITs represent a solid investment in a diversified investment portfolio.