Although it can be prone to fluctuation, the housing market has been a destination for investors to grow their earnings for decades. Buying and selling properties and becoming a landlord are two ways you can get in on the action. They’re not, however, the only options for real estate investing. If you can’t buy actual real estate, you can still invest in the real estate market by investing money in what’s known as a real estate investment trust (REIT).
What Is a REIT?
An REIT is a company that either owns income-producing properties or owns the mortgage on those properties. Typically, REITs specialize in a certain type of property, although you can also find hybrid trusts that offer a mix of investments. The REIT sells shares to investors, which you can purchase directly from the company or through an exchange-traded fund (ETF) or mutual fund.
When you purchase shares, you’re basically buying an interest in the properties held by the trust. When the properties appreciate in value, the REIT pays out the profits to shareholders as dividends. As long as the company’s investments continue to generate income, you should receive a steady stream of returns.
This allows you to reap the benefits of an improving market with fewer strings attached.
Types of REITs
REITs can take several forms, and you need to be aware of what the differences are before you invest.
Retail REITs are the most common type, making up about 24% of REITs. Typically, a retail REIT owns shopping centers, malls and freestanding retail establishments. They make their money by charging tenants rent. Therefore, their profitability is dictated in large part by the tenants’ ability to pay. As shopping continues to shift online and away from brick-and-mortar stores, retail REITs are facing increased pressure to adapt. However, there are plenty that still continue to pay strong dividends.
Residential REITs, rather than owning shopping centers, consist mostly of multi-family apartment buildings and mobile homes. Intuitively, a residential REIT performs well when rent of the buildings it owns is rising. Therefore, be on the lookout for REITs that own buildings in large cities with growing economies and low vacancy rates.
Office REITs invest in, you guessed it, office buildings. Again, they generate income by charging rent for the use of the property. When demand is high, dividends to shareholders are high as well. Similar to residential REITs, you’ll want to look at the strength of the economy, rent prices and vacancy rates when researching an office REIT. If there are plentiful businesses sprouting up and looking for office space in the area, that’s a good sign that dividends will be strong.
Healthcare REITs may be thought of as a mirror to retail REITs. While physical retail stores continue to lose business to online shopping, healthcare costs across the country continue to rise. Whether medical providers will benefit from these risings costs is a complicated question to answer. However, it’s reasonable to think that demand for health care will continue to increase as the U.S. population ages. Healthcare REITs own a range of medical care facilities including hospitals, clinics, retirement homes and assisted living facilities.
Mortgage REITs work a little differently, since they center on ownership of mortgage loans, rather than the property itself. Instead of turning a profit based on rental income, a mortgage REIT bases its returns on the interest paid on the loan. Mortgage REITs can be a nice way to diversify your holdings, even among REITs, since you’re not taking on any of the risk of actually owning real estate. However, these REITs have some risk of their own, since the value of existing mortgages is associated with the rise and fall of interest rates.
Pros and Cons of Investing in an REIT
Like any other investment, there are some advantages and disadvantages that go along with purchasing shares in an REIT. The most obvious plus is that it’s an easy way for investors to get involved in real estate investing. Unless you have a substantial amount of cash or other investors backing you up, buying multiple properties and trying to rent them out or sell them for a profit usually isn’t a realistic plan. With an REIT, you get to reap the rewards of a thriving real estate investment without needing to invest a lot of time and money upfront.
One downside of REITs, particularly mortgage REITs, is their susceptibility to interest rate fluctuations. Since changes in interest rates can significantly alter the value of mortgages on the resale market, REITs are particularly vulnerable to those changes in a way that typical stocks and bonds aren’t. REITs, as measured by the MSCI U.S. REIT index, have boasted higher annual returns than the S&P 500 since 2010, but that doesn’t mean they’re inherently better investments. Just two years earlier, many REITs suffered extreme losses due to the financial crisis and the key role that the real estate market played in it.
Investing in REITs can be a great way to include real estate in your investment portfolio without putting in the work of buying or selling properties. Like any investment, REITs come with their fair share of risk. Tenants who fail to pay rent or mortgages that lose value are both factors that are impossible to predict ahead of time. However, risk-free investments don’t exist, and REITs can provide you with strong dividends while diversifying your portfolio.
Tips for Investing Responsibly
- Want to take a look at what your portfolio will look like in a decade? SmartAsset’s investment calculator can help you do just that. Enter how much you have invested, how much you’re contributing and what rate of return you expect. We’ll then show you your investment growth five, 10 or even 30 years into the future.
- Like we mentioned, REITs can be a nice way to diversify your assets. However, they’re far from the only way to do so. If you like, you can invest in real estate properties themselves. Also, you can invest in commodities like precious metals, energy resources or even livestock.
- REITs are an intriguing investment product, but they can also be confusing to wrap your head around. Talking over your options with a financial advisor can help clarify the process. With SmartAsset’s free advisor matching tool, you can fill out a short survey and connect with up to three qualified advisors in your area.
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