Real Estate Investment Trust (REIT) Definition – What You Need to Know
Whether you are driving through the city and staring at office buildings, through the suburbs and looking at homes and apartments, or in the middle of the country passing endless miles of farmland, real estate is abounding. Here, we are going to think about real estate in a different light – as an investment opportunity. We want to look at the Real Estate Investment Trust (REIT) definition and how it may benefit you?
Real estate can be an important element of a diversified portfolio, potentially reducing volatility and acting as a hedge against inflation. While financing, owning and operating individual properties can be cumbersome and is not for everyone, REITs provide investors access to unique investments such as commercial properties.
Technically speaking, a REIT is a company that owns, operates or finances income-producing real estate and is required to distribute at least 90 percent of its taxable income to shareholders. There are two main types: Equity REITs and mortgage REITs. Equity REITs buy, sell, build, renovate and manage properties, generating their income mostly from rents collected. They invest in offices, industrial, retail, apartment complexes, hotel and resorts, and even single-family homes. On the other hand, mortgage REITs invest in mortgages or mortgage securities tied to commercial or residential properties, or both. They provide financing for income-producing real estate by buying or originating mortgages and mortgage-backed securities. Their income comes from the interest on the investments they make.
Most REITs are publicly traded and are relatively liquid, meaning it is easy for investors to increase or reduce their exposure to real estate. REIT investors can choose among a wide range of sectors and typically earn dividends on their investments and they require smaller capital outlays than direct investments in real estate.
Of course, there are downsides too.
REIT investors don’t enjoy the degree of capital leverage that comes with direct investment in property. They also don’t have the ability to write off operating and carrying costs for real estate. However, the Tax Cuts and Jobs Act of 2017 did allow an important advantage for REITs – investors can deduct 20 percent of income from REITs and other pass-through investments, lowering the maximum tax rate on REIT dividends from 37 percent to 29.6 percent.
Another important factor to consider is that REITs are interest-rate sensitive. This means that in a rising rate environment, like the one we have experienced over the last six months, share prices for REITs may decline. However, declines are often followed and offset by increases in REIT earnings and dividends. In fact, research shows that REITs historically have tended to outperform the S&P 500 during times of rising interest rates.
For sophisticated investors, private or non-traded REITs are still another option and generally offer higher dividends. Under federal securities law, these types of REITs may be offered only to accredited investors who earn at least $200,000/year (or $300,000/year combined income if married) or have a net worth of at least $1 million (excluding the value of one’s primary residence).
So, is real estate a good investment? Possibly.
At the time of this writing in mid-March 2018, real estate is one of the worst performing investments so far this year with the FTSE NAREIT All Equity REIT index down 7 percent in less than three months. Could it be a good investment in the future? With expectations of interest rates increasing, there is potential for more downside risk in the short term. However, for a long-term investor, real estate could be a good diversifier to a traditional stock and bond portfolio. As always, it is important to speak with your financial advisor to determine if real estate investing is appropriate for your situation.
Co-authored by Gary Williams, CFP and Nicholas Ibello, CFP.
Gary Williams, CFP® and Nicholas Ibello, CFP® are Wealth Managers with Williams Asset Management. They offer securities and advisory services as Investment Adviser Representatives of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Fixed insurance products and services offered by Williams Asset Management.
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