Real Estate Investment Trusts: What You Need to Know

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While there are many different types of investments to put your money into over the years, one type that has made   people wealthy is real estate investment. If you feel too overwhelmed by the thought of choosing, negotiating, renovating, refinancing, renting, and then selling investment properties though, you may want to consider putting some funds into a real estate investment trust (REIT). To help you consider whether this option will be suitable for you, read on for some key details you need to know.

What are REITs?

A real estate investment trust is a type of company that invests money into buying (or sometimes managing) income-producing real estate. REITs are similar to mutual funds and ETFs in a way, but instead of investing in stocks, they own a portfolio of properties and/or mortgages that are specifically kept to produce income. Either the properties themselves or the mortgages on the site can be the asset managed.

If you have always loved the idea of enjoying the benefits of owning some large-scale, income-producing real estate, but have never wanted to deal with finding new tenants or looking after maintenance and the like, this type of investment  might be right for you. REITs make it simple for investors to earn a share of real-estate income produced each year, without having to buy a whole property on their own.

A REIT investment can be in any type of property, but usually involves commercial real estate such as office buildings, malls, apartments, and hotels. Unlike more traditional real estate companies, REITs don’t develop and resell properties; instead they buy and develop them and then manage them as part of an investment portfolio. These trusts must have a minimum of 100 shareholders, and no five of these shareholders can own more than 50 percent of shares between them. In addition, to be qualified as an REIT, the trust must have at least 75 percent of its assets invested in property.

History of REITs

While you may not have heard much about REITs yourself, these types of trusts have existed for more than half a century. Congress granted legal authority to form REITs in 1960, as an amendment to the Cigar Excise Tax Extension of 1960, and President Eisenhower signed the REIT Act title into law. The legal move gave all investors the chance to invest in large-scale, diversified portfolios of real estate that produced an income.

Between 1960 and 1961 the first real estate investment trusts were launched. These were Bradley Real Estate Investors, Continental Mortgage Investors, First Mortgage Investors, First Union Real Estate (now Winthrop Realty Trust), Pennsylvania REIT, and Washington REIT. The latter three are still trading today on the New York Stock Exchange (NYSE), while Continental Mortgage Investors was the first to be listed, in June 1965. As of early last year, there were just under 200 REITs listed on the NYSE.

Historically, real estate investment trusts have been one of the best-performing asset classes. For example, between 1990 and 2010, the FTSE NAREIT Equity REIT Index (what most investors use to gauge U.S. real-estate market performance) had an average annual return of 9.9 percent. This puts it second only to mid-cap stocks, which averaged, in the same period, a little higher at 10.3 percent. In recent years, the index has also performed well. Between March 2013 and March 2016, the three-year average for REITs was 9.85 percent.

Different Types of REITs

It is important to be aware of the different types of real estate investment trusts that you can invest in. For starters, note that there are both publicly traded REITs, such as those mentioned above, as well as non-traded options.

Another distinction to make is between Mortgage REITs and Equity REITs. Mortgage REITs work by borrowing money (at low, short-term interest rates) to purchase mortgages that pay higher long-term interest rates. The trusts then make their money from the difference between the two rates.

On the other hand, Equity trusts own and operate income-producing real estate. Some trusts have a diverse type of portfolio while others decide to invest purely in one asset class, like retail investments (e.g., shopping malls and freestanding retail spaces); residential properties (e.g., apartment buildings); office buildings; or healthcare properties such as hospitals, nursing facilities, medical centers, and retirement homes.

Benefits of REITs

Real estate investment trusts have increased in popularity over recent decades because of the top returns they have showcased, as well as for the fact that they tend to provide a steady stream of income for investors, and allow people to include real estate in their portfolio without requiring hundreds of thousands or millions of dollars to buy something outright.

By law, REITs have to maintain dividend payout ratios of at least 90 percent of annual taxable net income (excluding capital gains) and this dividend is taxed as ordinary income rather than as corporate income, which saves on taxes.

While of course REITs do have some risks and limitations like any investment choice, they tend to provide investors with lower risk and potentially higher returns (not to mention greater diversification) than many other types of assets.