Real estate is one of the safest and most promising asset classes you can invest in, but it can be difficult to get started due to the exorbitant costs associated, from the transaction fees to the actual property price. Luckily, there is an alternative to buying into physical properties, and that is through a REIT or Real Estate Investment Trust.
What are REITs?
A REIT is a company that strategically owns or bankrolls income-yielding properties within various property segments. In order for a company to be considered a REIT, 75 percent of their total assets must be invested in real estate. They must also be making a gross minimum of 75 percent profit from rental properties, mortgage interest, real estate financing, and real estate sales. There are several other requirements to qualify as a REIT, and someone who is interested in starting one should be aware of said requirements to avoid any legal disputes or penalties.
Why Invest in REITs?
You may be asking yourself, are REITs good investments? REITs have historically produced competitive ROI compared to equity and bonds. In 2012, REITs returned a dividend yield of roughly 4.3 percent, which was well more than what the S&P 500 Index was able to generate a They offer both steady dividend yields and long-term capital appreciation. REITs also have a low correlation with other financial assets, making them a good option for portfolio diversification.
The tax treatment for REITs is also straightforward. Trusts send out a 1099-DIV form every year to its shareholders, containing information on how dividends were distributed. And because REITs are not taxed at a corporate bracket, shareholders are taxed at the standard income tax rate. Another benefit of a REIT is that shares are highly liquid since shares are bought and sold via an exchange, much like stocks on the stock exchange. On the other hand, flipping houses can cost more money, energy, and time.
What are the Disadvantages of REITs?
Profits generated by REITs move in correlation with other high-yield financial products, like Treasury bonds. Whenever interest rates on these products increase, REIT values decrease as people sell their REIT shares in search for better yielding assets.
In addition, REITs are subject to property taxes, even though they do not directly own any piece of real estate. This tax alone can constitute 25 percent of overall expenditures of a REIT’s operations.
What are the Types of REITs?
There are multiple types of REITs, which will affect how you invest in them. The most common one is known as Retail REIT. Roughly a quarter of REIT investments are in commercial malls and retail outlets, all of which collectively represent the largest investment by type in the country. Regardless of what shopping center you visit, there is a high chance that it is owned or bankrolled by a REIT.
Another type of REIT is residential, which own multi-family and manufactured housing. Most residential REITs are concentrated around dense urban areas. Each type of REIT involves different buy-in costs, payout schemes, legal restrictions, and strategies for making profits. For instance, retail REITs make money by collecting monthly rent from tenants that lease their spaces at a mall. Meanwhile, residential REITs might sell complete apartment building units at prime locations, like in New York or San Francisco.
Other types of REITs include Office, Mortgage, and Healthcare. When determining which one to invest in, you should keep in mind that the asset class is a pure total-return investment. Another thing to consider is that, unlike traditional properties, most REITs are bought and sold via stock exchanges. If you wish to skip all prior research and in-depth analysis, you can buy into a mutual fund or exchange traded fund that specializes in REITs.
Final Thoughts
Real estate investment trusts are ideal for investors who want to include real estate in their portfolio but do not want the hassles of buying and selling physical assets nor have the funds to purchase whole properties outright. Of course, like any financial product, there are risks associated with REITs that an investor should be wary of including potential tax implications, excessive fees, poor property selection strategy, ineffective management, and so on. Make sure you understand the risks involved as well as how to calculate taxes owed on any dividends collected.
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