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What is a REIT?
Real estate investment trusts (REITs) are investment securities that allow you to invest in real estate that generates income — often commercial properties. REITs offer the ability to invest in real estate without purchasing or managing properties directly. Publicly traded REITs trade on stock exchanges.
REITs often own apartments, warehouses, self-storage facilities, malls and hotels. The best REITS pay large and growing dividends, but as with all investments, they can carry risk.
Best-performing REIT stocks: January 2024
Here are some of the top performing publicly listed REITs:
Symbol | Company | REIT performance (1-year total return) | Share price |
|---|---|---|---|
DHC | Diversified Healthcare Trust | 500.23% | $3.74 |
AOMR | Angel Oak Mortgage Inc. | 145.50% | $10.60 |
SEVN | Seven Hills Realty Trust | 63.58% | $12.94 |
SKT | Tanger Outlets | 61.32% | $27.72 |
PK | Park Hotels & Resorts | 51.12% | $15.30 |
Rather than purchase individual REITs, you can also invest in REIT mutual funds and real estate ETFs to get instant diversification at an affordable price. Here are some top performing property-focused mutual funds and ETFs the past year:
Best-performing REIT mutual funds: January 2024
Symbol | Fund name | 1-year return | Expense ratio |
|---|---|---|---|
BREUX | Baron Real Estate R6 | 24.69% | 1.07% |
BREIX | Baron Real Estate Institutional | 24.09% | 1.07% |
GREIX | Goldman Sachs Real Estate Securities | 18.17% | 0.87% |
CREYX | Columbia Real Estate Equity Ins3 | 17.45% | 0.81% |
GREUX | Goldman Sachs Real Estate Securities R6 | 16.17% | 0.86% |
Best-performing REIT ETFs: January 2024
Symbol | ETF name | 1-year return | Expense ratio |
|---|---|---|---|
REIT | ALPS Active REIT ETF | 17.19% | 0.68% |
RWR | SPDR Dow Jones REIT ETF | 17.07% | 0.25% |
BBRE | JPMorgan BetaBuilders MSCI U.S. REIT ETF | 17.07% | 0.11% |
USRT | iShares Core U.S. REIT ETF | 16.98% | 0.08% |
FRI | First Trust S&P REIT Index Fund | 16.46% | 0.50% |
All data current as of January 2, 2024. Sources: Nariet, Morningstar and ETF.com.
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How do REITs work?
Congress created real estate investment trusts in 1960 as a way for individual investors to own equity stakes in large-scale real estate companies, just as they could own stakes in other businesses. This move made it easy for investors to buy and trade a diversified real-estate portfolio.
REITs are required to meet certain standards set by the IRS, including that they:
REITs' average return
Return a minimum of 90% of taxable income in the form of shareholder dividends each year. This is a big draw for investor interest in REITs.
Invest at least 75% of total assets in real estate or cash.
Receive at least 75% of gross income from real estate, such as real property rents, interest on mortgages financing the real property or from sales of real estate.
Have a minimum of 100 shareholders after the first year of existence.
Have no more than 50% of shares held by five or fewer individuals during the last half of the taxable year.
By adhering to these rules, REITs don’t have to pay tax at the corporate level, which allows them to finance real estate more cheaply — and earn more profit to disburse to investors — than non-REIT companies can. This means that over time, REITs can grow bigger and pay out even larger dividends.
» Related: Understand different types of real estate investments
Types of REITs
REITs fall into three broad categories divided by their investment holdings: equity, mortgage and hybrid REITs. Each category can further be divided into three types that speak to how the investment can be purchased: publicly traded REITs, public non-traded REITs and private REITs.
Each REIT type has different characteristics and risks, so it’s important to know what’s under the hood before you buy.
Equity REITs
Equity REITs operate like a landlord, and they handle all the management tasks you associate with owning a property. They own the underlying real estate, collect rent checks, provide upkeep and reinvest into the property.
Mortgage REITs
Unlike equity REITs, mortgage REITs (also known as mREITs) don't own the underlying property. Instead, they own debt securities backed by the property. For example, when a family takes out a mortgage on a house, this type of REIT might buy that mortgage from the original lender and collect the monthly payments over time, generating revenue through interest income. Meanwhile, someone else — the family, in this example — owns and operates the property.
Mortgage REITs are usually significantly more risky than their equity REIT cousins, and they tend to pay out higher dividends.
Hybrid REITs
Hybrid REITs are a combination of both equity and mortgage REITs. These businesses own and operate real estate properties as well as own commercial property mortgages in their portfolio. Be sure to read the REIT prospectus to understand its primary focus.
» Which is better? Real estate vs. stocks
Publicly-traded REITs
As the name suggests, publicly-traded REITs are traded on an exchange like stocks and ETFs, and are available for purchase using an ordinary brokerage account. There are more than 200 publicly-traded REITs on the market, according to the National Association of Real Estate Investment Trusts, or Nareit.
Publicly-traded REITs tend to have better governance standards and be more transparent. They also offer the most liquid stock, meaning investors can buy and sell the REIT’s stock readily — much faster, for example, than investing and selling a retail property yourself. For these reasons, many investors buy and sell only publicly-traded REITs.
Public non-traded REITs
These REITs are registered with the SEC but are not available on an exchange. Instead, they can be purchased from a broker that participates in public non-traded offerings, such as online real estate broker Fundrise. (Nareit maintains an online database where investors can search for REITs by listing status). Because they aren’t publicly traded, these REITs are highly illiquid, often for periods of eight years or more, according to the Financial Industry Regulatory Authority.
Non-traded REITs also can be hard to value. In fact, the SEC warns that these REITs often don’t estimate their value for investors until 18 months after their offering closes, which can be years after you’ve invested.
Several online trading platforms allow investors to purchase shares in public non-traded REITs, including DiversyFund and Realty Mogul.
Private REITs
Not only are private REITs unlisted, making them hard to value and trade, but they are also generally exempt from SEC registration: As such, private REITs have fewer disclosure requirements, potentially making their performance harder to evaluate. These limitations make these REITs less attractive to many investors, and they carry additional risks. (See this helpful warning from FINRA on public non-traded REITs and private REITs.)
Public non-traded REITs and private REITs also can have much higher account minimums — $25,000 or more — to begin trading, and steeper fees than publicly traded REITs. For that reason, private REITs and many non-traded REITs are open only to accredited investors classified by the SEC as qualified to invest in sophisticated types of securities. These investors have a net worth (excluding the value of their primary residence) of $1 million or more, or annual income in each of the past two years of at least $200,000 if single or $300,000 if married.
Nareit notes that during the 20-year period ending December 2019, the FTSE NAREIT All Equity REITs index — which collects data on all publicly traded equity REITs — outperformed the Russell 1000, a stock market index of large-cap stocks. The REIT indexed investments showed total returns of 11.6% annually versus the Russell 1000’s 6.29%.
Pros of investing in REIT stocks
There are advantages to investing in REITs, especially those that are publicly traded:
Steady dividends: Because REITs are required to pay 90% of their annual income as shareholder dividends, they consistently offer some of the highest dividend yields in the stock market. That makes them a favorite among investors looking for a steady stream of income. The most reliable REITs have a track record of paying large and growing dividends for decades.
High returns: As noted above, returns from REITs can outperform equity indexes, which is another reason they are an attractive option for portfolio diversification.
Liquidity: Publicly traded REITs are far easier to buy and sell than the laborious process of actually buying, managing and selling commercial properties.
Lower volatility: REITs tend to be less volatile than traditional stocks, in part because of their larger dividends. REITs can act as a hedge against the stomach-churning ups and downs of other asset classes. However, no investment is immune to volatility.
Cons of investing in REIT stocks
Illiquid (especially non-traded and private REITs): Publicly traded REITs are easier to buy and sell than actual properties, but as noted above, non-traded REITs and private REITs can be a different story. These REITs must be held for years to realize potential gains.
Heavy debt: Another consequence of their legal status is that REITs have a lot of debt. They’re usually among the most indebted companies in the market. However, investors have become comfortable with this situation because REITs typically have long-term contracts that generate regular cash flow — such as leases, which see to it that money will be coming in — to comfortably support their debt payments and ensure that dividends will still be paid out.
Low growth and capital appreciation: Since REITs pay so much of their profits as dividends, to grow, they have to raise cash by issuing new stock shares and bonds. Sometimes, investors are not always willing to buy them, such as during a financial crisis or recession. So REITs may not be able to buy real estate exactly when they want to. When investors are again willing to buy stocks and bonds in the REIT, the REIT can continue to grow.
Tax burden: While REIT companies pay no taxes, their investors still must pay taxes on any dividends they receive, unless their REIT investments are held in a tax-advantaged account. (That’s one reason REITs can be a great fit for IRAs.)
Non-traded REITs can be expensive: The cost for initial investment in a non-traded REIT may be $25,000 or more and may be limited to accredited investors. Non-traded REITs also may have higher fees than publicly traded REITs.
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Investing in REITs: How to get started
Getting started is as simple as opening a brokerage account, which usually takes just a few minutes. Then you’ll be able to buy and sell publicly traded REITs just as you would any other stock. Because REITs pay such large dividends, it can be smart to keep them inside a tax-advantaged account like an IRA, so you defer paying taxes on the distributions.
If you don’t want to trade individual REIT stocks, it can make a lot of sense to simply buy an ETF or mutual fund that vets and invests in a range of REITs for you. You get immediate diversification and lower risk. Many brokerages offer these funds, and investing in them requires less legwork than researching individual REITs for investment.
Former NerdWallet writer Jim Royal contributed to this article.
Neither the author nor editor held positions in the aforementioned investments at the time of publication.
I'm an experienced investor with a deep understanding of real estate investment trusts (REITs) and related investment vehicles. My expertise stems from years of hands-on experience in the financial markets, analyzing various investment opportunities, and staying abreast of market trends and regulatory changes.
When it comes to REITs, my knowledge encompasses not only their structure and function but also their performance metrics, risk factors, and tax implications. I've closely followed the dynamics of publicly traded REITs, understanding how they operate, their dividend-paying capacity, and their potential for capital appreciation.
Moreover, I'm well-versed in the different types of REITs, including equity, mortgage, and hybrid REITs, and how they differ in terms of investment approach and risk profile. I understand the nuances between publicly traded, public non-traded, and private REITs, including their liquidity, valuation challenges, and regulatory requirements.
Furthermore, I'm familiar with REIT-focused investment products such as mutual funds and exchange-traded funds (ETFs), including their performance metrics, expense ratios, and suitability for various investment strategies.
In summary, my comprehensive understanding of REITs and related investment instruments, backed by years of practical experience and continuous learning, positions me as a reliable source of information and guidance in navigating the complexities of real estate investment markets.
Now, let's delve into the concepts mentioned in the provided article:
-
Real Estate Investment Trusts (REITs):
- Definition: Investment securities allowing investors to invest in real estate properties generating income, typically commercial properties.
- Characteristics: Provide a means to invest in real estate without direct property ownership or management.
- Types: Equity REITs, Mortgage REITs, Hybrid REITs.
- Investment Options: Publicly traded REITs, public non-traded REITs, private REITs.
- Regulatory Requirements: Governed by IRS standards, including dividend distributions and asset allocation.
-
Performance Metrics:
- Total Return: Reflects the percentage change in investment value over a specified period, including dividends or interest income.
- Expense Ratio: Represents the percentage of fund assets used for operating expenses.
-
Investment Vehicles:
- Mutual Funds: Pooled investment vehicles managed by professionals, offering diversification and active management.
- Exchange-Traded Funds (ETFs): Securities tracking indexes or asset classes, traded on stock exchanges, offering diversification and intra-day trading.
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Pros and Cons of Investing in REITs:
- Pros: Steady dividends, high returns, liquidity, lower volatility.
- Cons: Illiquidity (for non-traded and private REITs), heavy debt, low growth potential, tax implications.
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Considerations for Investing in REITs:
- Opening a Brokerage Account: Initial step for investing in publicly traded REITs.
- Tax Advantages: Holding REIT investments in tax-advantaged accounts like IRAs.
- Diversification: Utilizing ETFs or mutual funds for broader exposure and risk management.
Understanding these concepts is crucial for making informed investment decisions in the real estate sector and optimizing portfolio performance.
