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August 4, 2020

Understanding different types of REITs

REITs (Real Estate Investment Trusts) are companies that invest in real estate. They pool together investors to purchase, develop, and possibly maintain real estate, and pay those investors in the form of dividends. REITs are somewhat like shares and can be bought and sold on the stock market.

REITs give small investors a chance to invest in large real estate projects that they were previously barred from. A single investor may not have enough capacity to invest in a diversified, multimillion real estate property on her own, but given an opportunity to join a group of investors, she can obtain the benefits and gains from real estate investments in her portfolio.

Just like companies and shares, REITs can come in many different types, industry sectors, and price points. It can be exciting to decide which type of REIT you want to invest in, so here’s a quick overview of the types of REITs you might come across in your research:

Retail REITs
Retail REITs are one of the most popular types of REITs in the US, with around 24% of all REIT investments being in retail. These REITs invest in properties like malls, outlet centers, grocery-anchored shopping centers and are impacted by trends in retail and consumer spending.

Residential REITs
Residential REITs are invested in apartment buildings and multifamily housing. These REITs are impacted by the rental market in that location, employment figures in the market, and the overall economy.

Healthcare REITs
Healthcare REITs focus on a timely and relevant issue because they are directly tied to the healthcare system. In long-term trends, as the population ages and the need for more healthcare space and facilities grows, it’ll be interesting to see how healthcare REIT prices and value are influenced.

Office REITs
Office REITs invest in office buildings with multiple business tenants. Valuation of office REITs depends on economic conditions such as the unemployment rate, area vacancy rates, and work from home trends.

Specialized REITs
Specialized REITs offer a way to capture demand for real estate in other industry sectors. Data center REITs own and manage facilities that customers use to safely store data. Storage REITs own and manage storage facilities and collect rent from customers. Mortgage REITs are shares that, instead of being tied to commercial or home equity, are directly tied to the mortgages on the property.

Understanding the risks of investing in REITs

Interest rate risk: Interest rates can have a massive influence on REIT stock prices. In general, rising interest rates are bad for REIT prices. In today’s low interest rate environment, especially with no signs of rising interest rates in the short- to medium-term, REITs can be a good investment strategy.

Economic risk: some types of REITs may be susceptible to economic downturns or recessions. Retail REITs that focus on malls or department stores, for example, may be impacted by macroeconomic factors like trade wars, import/export activity, etc.

The benefits of investing in REITs

Now that you understand the breadth of REITs out there available for you to invest in, you might be wondering if you should start investing into this asset class. There are many ways a portfolio can benefit from the addition of REITs:

Diversification: The true benefit of REITs lies in the diversification it provides to the average individual portfolio. Historically, real estate returns have been more stable and consistent than stock market returns. In recessions or economic slumps, REITs can stabilize free-falling equity portfolios as can be seen below:

Liquidity: An investor no longer has to provide considerable capital to begin investing, and nor do they have to worry about selling a property to the right seller to liquidate their holdings.

Inflation protection: When inflation rises, the rents on housing and retail also increase—and in return, so does the value of the REIT. This can provide a hedge against inflation in the long term.

The takeaway

When you start investing in REITs, your first step should be to look at the different industry sectors and markets that you can invest in. As we mentioned previously, risk and return characteristics differ across REITs—industry sectors don’t all respond alike to changes in the market and economy. This is what makes REITs so interesting and attractive as an investment—there are options available to truly fit every kind of investor and portfolio.

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