Understanding REITs: A Beginner’s Guide to Real Estate Investing

Have you ever wanted to invest in real estate but found it too complicated or costly? Real Estate Investment Trusts, or REITs, might be a good solution for you. This article will explain what REITs are, their requirements, benefits, and how they can be structured.

A real estate investment trust (“REIT”) is a company that owns, operates, or finances real estate across a range of property sectors. They allow individual investors to earn a share of the income produced through real estate ownership without having to buy, manage, or finance any properties themselves. Essentially, investing in a REIT is like buying stock in a company that owns real estate. When you invest in a REIT, you are buying shares in a portfolio of properties, such as shopping malls, office buildings, apartments, or hotels.

There are a number of requirements and benefits to the REIT structure:

Requirements:

• Asset Composition: Invest at least 75% of total assets in real estate related assets.
• Income: At least 75% of gross income must come from rents on real estate, mortgages on real estate, or the sale of real estate.
• Distribution: Pay at least 90% of its taxable income to shareholders in the form of dividends.
• Ownership: Have a minimum of 100 shareholders and have no more than 50% of the fund’s shares held by five or fewer individuals.

Benefits:

• Tax Efficiency: Unlike owning a share of stock in a corporation, REITs typically do not pay corporate income tax on the income they distribute. This setup allows more earnings to be passed directly to investors rather than being taxed at both the corporate and individual levels.
• Income Generation: REITS typically offer high dividends due to 90% income requirement.
• Diversification: REITs provide a way to diversify your investment portfolio, especially considering that a single REIT can offer exposure to a variety of properties. Historically, REITs have experienced similar long-term total returns as stocks but with only moderate correlation, adding diversification benefits.
• Inflation Hedge: Real estate has historically been viewed as a hedge against inflation. As prices rise, property values and rents may also increase, potentially providing REIT investors with a safeguard against inflationary pressures.
• Liquidity: Publicly traded REITs are typically more liquid, meaning easier to sell, than direct real estate investments.
• Professional Management: REITs are managed by professionals who are experienced in the real estate market. This means you may benefit from their expertise without needing to manage properties yourself.

Explaining Common REIT Structures

REITs are broadly divided into equity REITs and mortgage REITs. Equity REITs primarily invest in and manage income-producing real estate. They generate revenue through leasing space and collecting rents from tenants. Equity REITs tend to focus on various sectors, including residential, commercial, healthcare, and industrial properties. The performance of equity REITs is closely tied to the real estate market, making them sensitive to fluctuations in property values and rental income.

Alternatively, mortgage REITs do not own property directly. Instead, they provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities . Their income is generated primarily through the interest earned on these financial products. Mortgage REITs may be more sensitive to interest rate changes, which can impact their profitability.

REITS Compared to Traditional Stocks

Looking back 25 years as of 09/30/2024, using the FTSE Nareit All REITs index  as a proxy for REITS and the S&P 500 as a proxy for stocks, we find that the correlation between the two is 0.67. A correlation of 1.00, or -1.00, is deemed perfectly correlated, or perfectly negatively correlated, while a correlation of 0.00 is said to have no correlation. During this period, the annualized total return for REITs was 7.85% while the annualized total return for stocks was 8.18%. The dividend contribution to those returns was around 2.0% for stock and 3.4% for REITs. [1]

From this data, we can infer that REITs have historically had a similar return to stocks while offering a bit of diversification due to only a moderate correlation. REITs also typically offer a higher yield than stocks due to the underlying assets generating rental income or mortgage interest.

REIT Subsectors

Individual REITs normally focus on a particular type of real estate, although there are some diversified REITs. These subsectors include:

• Datacenters
• Industrial
• Residential
• Hotel
• Self-storage
• Infrastructure
• Healthcare
• Office
• Retail
• Gaming

Each REIT subsector has unique characteristics and benefits. For example, self-storage leases can be as short as 1 month while land leases can be as long as 99 years. Further, gaming REITs have simple structures where most expenses like insurance, taxes, and maintenance are paid by the tenants. Alternatively, residential REITS not only pay those expenses but have significant staffing and marketing expenses as well. These unique characteristics allow investors, especially portfolio managers of REIT funds, to pursue opportunities for outperformance based on evolving demographic, economic, and even political trends.

In Conclusion

REITs provide a unique opportunity for investors to gain exposure to the real estate market without the complexities of direct ownership. Whether you’re seeking diversification, income, or a hedge against inflation, incorporating REITs into your investment strategy could be a valuable addition to your portfolio. As always, it’s crucial to conduct thorough research or consult with a financial advisor to align your investment choices with your financial goals and risk tolerance .

[1] Source: Bloomberg LP as of 9/30/24.

The data and analysis contained herein are provided “as is” and without warranty of any kind, either expressed or implied. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results.

Past performance is no guarantee of future results.

Diversification does not eliminate the risk of experiencing investment loss.

Definitions:

Mortgage-backed Security: A mortgage-backed security is a type of asset-backed security which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals that securitizes, or packages, the loans together into a security that investors can buy.

Correlation: Correlation is a statistical measure that describes the degree to which two variables move in relation to each other. A positive correlation indicates that as one variable increases, the other also tends to increase, while a negative correlation shows that as one variable increases, the other tends to decrease.

S&P 500 Index: The S&P 500 is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S., designed to measure the overall performance of large-cap U.S. stocks and often used as a benchmark for the broader U.S. equity market performance.

FTSE Nareit All REITs Index: The FTSE Nareit All REITs Index is a benchmark that tracks the performance of all publicly traded REITs in the U.S. It includes a diverse range of property types and is designed to reflect the overall health and performance of the REIT sector, providing investors with insights into real estate market trends.

One cannot invest directly in an index.

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