REIT is an abbreviation that means Real Estate Investment Trust. To fully appreciate the REIT Advantages and Disadvantages, it is essential to understand the term’s meaning.
The TLDR is that a REIT is a company that invests in one or more real estate projects. The company could be the owner, a financier, or an operator of the real estate project. By pooling funds together, REITs enable ordinary people without massive bank accounts to invest in otherwise inaccessible mega projects. As we shall discuss later, it is one of the most significant REIT Advantages and Disadvantages.
Major Types of REITs
There are four main types of REITs, including:
- Equity REITs are public companies that are on the stock market. They operate income-producing real estate.
- mREITs or mortgage REITs buy mortgages or mortgage-backed securities and earn profit from the interest.
- Public Non-listed REITs are SEC-registered but are not on the stock exchange. They are also known as PNLRs.
- Private REITs are not publicly traded and are exempt from registration with the SEC.
Advantages of REITs
REITs are similar to mutual funds, but rather than investing in stocks; they invest in real estate assets. The nature of REITs gives them several benefits that mutual funds do not. The following are the advantages of REITs.
1 | They Diversify Your Investment Portfolio
One of the essential considerations you make when investing is how to minimize your risk. REITs enable you to diversify your investment portfolio hence minimizing your risk. The prospect of reducing your risk makes this one of the more prominent REIT Advantages and Disadvantages.
But, how do REITs enable you to mitigate your risk? REITs own or operate many types of real estate properties. A branched-out pool of tenants means that the REIT experiences lower risk than companies investing in single properties with few tenants.
For example, if you own a single retail outlet that shuts down because of unforeseen circumstances, its value would depreciate. Moreover, you will earn no rental income when it stops operating. To reduce the impact of such a loss, a REIT invests in multiple real estate projects with different characteristics. Therefore, if the performance of some investments declines, profits from other investments steady the REIT’s income.
Diversification is not just about risk, though. REITs also enable you to invest in properties across states, cities, and countries. People unable to invest in overseas properties can get involved by investing in REITs.
2 | Above Average Investment Returns
REITs are an excellent way for people to build their passive income. Returns are a critical part of most REIT Advantages and Disadvantages. For starters, REITs must disburse a minimum of ninety percent of their taxable income to investors. Therefore, the dividend yield to shareholders is above average for most REITs.
There are many REITs with more than a 5% dividend payout, while the average yield for stocks is two percent or lower. REITs are therefore ideal for people who wish to reinvest their dividends. In the past 20 years, the return for REITs has outperformed the S&P 500 Index and the inflation rate.
In addition to providing high returns, REITs also allow for stable capital appreciation in the long term. They are one of the most popular long-term investment vehicles available.
3 | High Earning Potential
One of the REIT Advantages and Disadvantages comes from the fact that the underlying asset in REITs is real estate. When the underlying asset’s value increases, your earning potential follows suit.
The value of real estate investment often increases in the long run. With this knowledge, most REITs employ strategies to create additional value for their shareholders. For instance, they could sell off properties that have appreciated significantly to generate capital for new projects, which might provide higher short-term growth. The underpinning reason is that most real estate projects grow fastest when they are newly completed, but the rate of growth levels off and might eventually stagnate.
By combining high dividends and capital appreciation, REITs provide their shareholders with substantially better return potential. REITs often deliver returns that beat the market for many consecutive years.
4 | High Liquidity
Buying and selling physical properties might take a long time, and you might incur high costs. However, buying shares in a public REIT takes much less time and effort. If you want to liquidate the money in your REIT investment, you can sell it at the click of a button.
You also get significantly better liquidity from a private REIT compared to owning physical property. Most private REITs allow you to sell your shares back to them at a slight discount for the first few years. The transaction takes minimal time and is much easier than dealing with direct property sales.
5 | REITs Give you Access to Commercial Real Estate.
Few REIT advantages and disadvantages beat the opening up of investment in commercial properties. Investing in commercial real estate properties is usually reserved for people with access to significant capital.
With REITs, however, you can invest in data centers, shopping malls, apartment complexes, etc. If you have a particular commercial property you want to invest in, you could look for a REIT that invests in the property and buy its shares.
6 | Minimal Management and Acquisition Headaches
Most people who have invested in physical properties know the pain involved in buying, selling, and managing properties.
The truth is that nobody wants tenants calling them at 3 AM to complain about blown fuses. Furnaces like to break down at the worst times, and termites might be eating your investment without your knowledge. All these are annoyances that most investors do not want.
A REIT has professionals that deal with resolving the minor inconveniences that investors could not be bothered to fix. When you invest in a REIT, you can forget about it and go about your other affairs as you wait for the dividend checks.
7 | REITs are a Consistent Income Stream
Many assets managed by REITs have long-term leases associated with them. Therefore, income flow from these investments is mostly assured to continue predictably.
8 | Invest as Little as you Want
Many REITs do not specify the minimum amount you can invest. Therefore, they are ideal for people who want to invest but do not have a lot of disposable income.
Disadvantages of REITs
REITs suffer from some of the drawbacks of investing in stocks. These are the most significant disadvantages of investing in REITs.
1 | Weak Growth
REITs that trade on the stock exchange disburse a large proportion of their income to investors. Unfortunately, very little money is left to allow a REIT to grow its portfolio. Fortunately, private REITs do not follow the same rules and may be able to retain more earnings for further investment.
2 | High Taxes on Dividends
The dividends you earn from REITs are subject to higher taxes than other investments.
You are usually only supposed to pay a capital gains tax on dividends. However, REIT returns do not qualify—they are subject to ordinary income tax rates. Of course, this largely depends on the country you live in.
3 | Potentially High Fees and Risk
Even if a REIT is SEC-registered, it doesn’t mean it is low-risk. Investors should consider factors such as interest rates, the real estate market, tax laws, geography, etc., before investing in REITs.
Some REITs may use these factors to justify charging high management fees and transaction fees. The result is a lower payout to investors.
On a positive note, most fees that a REIT charges are often in the fine print.
4 | Trends Affect the Performance of REITs
Compared to other investments, REITs are vulnerable to the goings-on in the real estate market. For instance, if a REIT has a significant investment in rental properties in a location with diminishing rental income, the returns for shareholders are likely to trend downwards.
Fluctuations linked to the real estate market are more problematic for REITs to avoid because it is their sole investment destination.
5 | Little Control Over Performance
The level of control of the investment is one of the REIT Advantages and Disadvantages that favors people who invest in physical properties. If you invest funds by yourself, you can cherry-pick properties with high returns, aggressively promote vacant rental spaces, and thoroughly screen applications for rental agreements to maximize revenue and minimize risk. You have much tighter control of how you implement real estate best practices.
On the other hand, if you invest in a REIT, you can’t do anything to influence the performance of your investment. If you don’t like its returns, your only viable option is to sell it. Another downside is that some private REITs don’t allow you to sell your shares for several years after buying them.
There can be no better proof of the relative safety of investing in the real estate market. Some analysts are concerned that the housing market has been burning too bright. However, even if there is a correction, it might have little effect on the performance of real estate investments in the long run. There is consensus that one of the REIT Advantages and Disadvantages is that it is an excellent long-term investment despite suffering from significant short-term upheavals. REITs are the perfect investment vehicle for anybody looking to invest while avoiding the volatility of the stock markets.
If you want to learn more about commercial real estate, PropTech, smart cities and smart buildings, feel free to take a look at our other articles.