February 17, 2022
Diversifying an investment portfolio can include a number of different strategies, and a growing number of investors are turning to REITs, or Real Estate Investment Trusts, as a smart way to build wealth. Instead of purchasing individual pieces of property and assuming the responsibilities that go along with it, an REIT allows investors to buy into a collection of properties and enjoy regular dividends from those holdings. If you’re unsure how this type of real estate investing works, here’s a closer look at REITs, how they work, and what they can do for your portfolio.
Simply put, REITs are companies that own a collection of real estate properties, collecting rents and revenues on each holding. The capital used to purchase the properties is pooled together from a group of investors, allowing the group to share in both the risks and rewards of the portfolio of investments. Those who invest see regular dividends paid out from the rents collected, and the REIT may use some dividends to invest in additional holdings.
Companies must meet certain conditions to be considered an REIT. These conditions include:
When all these requirements are met, a company meets the threshold set by the SEC to become an REIT.
REITs do more than just provide returns for the investor. In 2020, REITs held in the United States generated more than $197 billion in labor income and brought the equivalent of an estimated 2.9 million full-time jobs to the economy. Investors can feel peace of mind knowing their contributions yield benefits beyond regular dividend distributions.
An examination of the historical returns for REITs shows why this type of investment may be a smart choice for expanding your portfolio. The current trailing 25-year annualized return of the FTSE Nareit All-Equity REITs index sits at 10.5%, keeping in line with the index’s track record for performing for investors. In fact, the returns of the FTSE Nareit All-Equity REITs index have outpaced the S&P 500 across several historical periods, with residential REITs consistently showing strong performance.
There are three main types of REITs available to investors: private, public, and public non-traded.
Public REITs are traded on a stock exchange, which results in them being a very liquid investment. Shares can be traded frequently throughout the day, so long-term holdings are not required. Individual investors can buy and sell their shares at their discretion, and SEC regulations apply to these types of share purchases.
Private REITs are not traded on any markets and typically have set rules regarding how long the investment must be held before selling off shares. Investments are only open to Qualified Institutional Buyers (QIBs), such as banks, pension plans, and insurance companies, and they are not subject to the same SEC regulations as public REITs.
Public Non-Traded REITs combine some key elements of private and public options. Investors may be required to hold their investments for a set period of time, providing limited liquidity but also offering a smart long-term addition to your portfolio. When investing in a public non-traded REIT, individual investors enjoy certain protections in the form of SEC regulations. DiversyFund is a public non-traded REIT, giving investors the benefits of long-term holdings and compliance with SEC regulations.
REITs typically come in two main investment types: equity and mortgage. Equity REITs invest directly in properties by purchasing and maintaining them to generate revenue from rents collected each month. Dividends are paid out based on the monthly income earned by the rental properties. Mortgage REITs, also known as mREITs, are those that invest in mortgages and mortgage-backed securities. Investors see returns based on the interest generated by the collection of loans.
Some investors may see mREITs as a more risky option, as returns are dependent upon favorable interest rates and solid loan performance. Equity REITs may offer more stable growth as a long-term investment option because performance is not as reliant on markets as it is on low vacancy rates and timely compliance on the part of tenants.
Hybrid REITs are a third option available to investors, combining features from both equity and mortgage investments to borrow benefits from both. A hybrid REIT might own several rental properties for consistent revenue while also investing in mortgages and mortgage-backed securities to potentially yield higher returns.
When investing in a public or private non-traded REIT, you’ll also need to determine the industry you want to buy a piece of. There are many different REIT industries to choose from, including:
Each industry represents a different type of real estate investment portfolio. Residential REITs might include apartments and apartment complexes with rents from individual residents driving the portfolio’s growth, while hospitality REITs might invest in a group of hotels or hotel chains across the country. Retail REITs often include shopping malls and centers where tenants pay monthly rent to operate in those spaces. As you look at the different industries available, take the historical returns into account for each sector to help inform your decision.
So what can an REIT do for an individual investor? REITs, particularly equity REITs, are set up to make investing in real estate achievable for everyone. You don’t have to have the capital to purchase a property on your own, and you don’t have to worry about acting as a landlord or maintaining properties after they are purchased. In an ever-changing real estate market, REITs let you take advantage of the market and expand your portfolio. You share risk and reward with other investors and provide yourself with a long-term source of revenue in the form of dividends. REITs can help you begin to build generational wealth or simply supplement a diverse investment strategy.