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Office building owned by a REIT

When it comes to building a strong portfolio, there are many different investment vehicles to choose from. One such vehicle is the REIT, which allows investors to put their money into real estate-based assets without the risk and hassle of individually owning a property. There are a few different types of REITS to choose from, however. Here’s a look at the main types of REITs available to investors and how to invest in each one.

Picking one or more REITs to invest in can be a challenge, given all the choices. A financial advisor can offer invaluable advice about how to make that decision.

What Is a REIT?

First, let’s talk about what a REIT is in the first place. REIT is an acronym that stands for real estate investment trust. A REIT is essentially a company that funds, manages, maintains and sometimes sells a range of investment assets.

REITs behave similarly to a mutual fund, in that individuals are able to invest in shares of the company as a whole. When the assets owned and managed by the company appreciate and profit, the investors recognize proportionate growth.

Investors don’t actually have to manage the asset in any way, though. The company itself will choose projects, develop land, seek out and manage tenants, make repairs, etc. At the same time, investors can diversify their portfolio while also helping to hedge against market downturns and even inflation.

According to the IRS, REITs are required to pay out at least 90% of their taxable income in the form of dividends. This makes them a good source of passive income for many investors.

The Three Types of REITs

So, what kind of REITs might you consider? There are three to choose from:

Each has its own purpose and benefits. Depending on your investment style and goals, one may be a better choice for you and your portfolio than the others.

Mortgage REIT (mREIT)

A mortgage REIT, or mREIT, doesn’t actually own any physical assets. Instead, it originates or purchases mortgages or mortgage-backed securities (MBS). These can be either residential or commercial in nature, and most are traded on major stock exchanges the same as the exchange-traded funds (ETFs) or mutual funds you may already own.

Mortgage REITs play a very important role in our country’s financial markets. They provide the liquidity that both residential and commercial mortgage lenders may need to purchase property and have been responsible for funding more than 1.7 million home mortgages.

As the mortgages and MBS held by the mREIT earn interest from borrowers, investors will be rewarded in the form of dividend payouts. Mortgage REITs are generally known for offering high dividends, though they are easily impacted by changing market interest rates.

How to Invest in Mortgage REITs

Mortgage REITs may be publicly traded, public but not listed or privately traded.

Publicly traded mREITs may be found on major stock exchanges and provide investors with an easy way to both buy and sell shares. Public non-listed mREITs are generally sold by brokers or financial advisors. Though they aren’t as prone to market volatility, they also don’t provide the same liquidity as publicly traded shares.

Private mREITs are not sold on major stock exchanges and aren’t subject to SEC regulations. They are less volatile than public shares but are generally offered by private companies and may be difficult to liquidate when needed.

Pros and Cons of Mortgage REITs

Pros:

  • Typically offer higher dividends than other REIT types
  • Investors aren’t responsible for managing assets
  • Most shares are sold on public stock exchanges
  • Play an integral role in US mortgage markets

Cons:

  • May be easily affected by rising and falling interest rates
  • Borrowers who prepay or refinance their mortgage loans can impact returns
  • Most returns are taxed as ordinary income

Equity REIT (eREIT)

REIT documents

An equity REIT, or eREIT, is a REIT that focuses on building, developing, managing, repairing and sometimes selling investment property. Investors are not responsible for any of the day-to-day management of the assets held in the equity REIT, making it a very hands-off and simple form of real estate investing. They also allow individuals to invest in properties and projects that they might not otherwise be able to afford. The properties held and managed by an eREIT might be residential or commercial in nature, or even a blend of the two types, and could include the following:

  • Single- or multi-family homes
  • Apartment complexes
  • Commercial buildings
  • Office spaces
  • Storage buildings
  • Shopping centers

As the properties in the equity REIT earn income through rent (from tenants) or otherwise appreciate, investors will receive dividends from that taxable income. Investors can also recognize growth by selling those shares down the line at an appreciated price.

How to Invest in Equity REITs

As with mREITs, equity REITs are most often publicly traded on major stock exchanges. This means that they can be purchased and sold easily through investors’ preferred brokerages.

Some equity REITs may be public non-listed or even privately traded. Both offer lower volatility to eligible investors but are also more illiquid investments overall.

Pros and Cons of Equity REITs

Pros:

  • Add real estate interests to an investment portfolio without needing to manage those properties directly
  • Investors can choose REITs that match their interests (residential vs. commercial, for instance)
  • Dividends are offered and can provide investors with passive income
  • Historically, eREIT yields have been higher than S&P 500 average yields

Cons:

  • May be impacted by industry cycles and market rate changes
  • Investors don’t have control over the projects or management
  • Some REITs may have high fees
  • Most returns are taxed as ordinary income

Hybrid REIT

Put simply, a hybrid REIT is one that combines both mortgage and equity investments. A hybrid REIT will hold a blend of property assets – such as commercial buildings or apartment complexes – while also funding new or purchasing existing mortgages.

This can be a middle-of-the-road option for investors who aren’t sure of which REIT to choose. By including both types of investment within the hybrid REIT, investors are able to further minimize risk regardless of market trends.

How to Invest in Hybrid REITs

Hybrid REITs may be publicly or privately traded, the same as mortgage and equity REITs. Publicly traded hybrid REITs are available on stock market exchanges and are considered fairly liquid investments. Privately traded or public non-listed REITs, however, are only available to eligible investors and may be much more difficult to liquidate.

Pros and Cons of Hybrid REITs

Pros:

  • May help limit risk by diversifying into both types of REITs
  • Good option for investors who can’t decide or want both
  • Help to further diversify an investment portfolio
  • Generate income from both tenant rental payments and loan interest

Cons:

  • Low volatility generally equates to lower returns
  • Most returns are taxed as ordinary income

Bottom Line

REIT investors

Real estate investment trusts, or REITs, allow investors to diversify their portfolios and hedge against both risk and inflation. They also make it easy for investors to add real estate interests to their portfolio, without the hassle and headache of actually overseeing those projects. There are three main types of REITs to choose from, each of which may offer dividends as a form of passive income. REITs can play an integral role in either a growth- or value-focused retirement portfolio.

Tips on REITs

  • Not sure how REITs can play into your short- and long-term investment strategy? A qualified financial planner may be able to help. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you invest in REITS make sure you have allocated such assets properly within your overall portfolio. One way to make sure you keep various types of securities in the correct proportions is by using SmartAsset’s asset allocation calculator.

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