Real Estate Investment Trusts (REIT) offer a powerful tool to generate passive income. Comprised of companies owning, operating or financing income-producing properties, they’re a little different from regular companies.
They invest in real estate — or loans on real estate, with many generating the bulk of their income (up to 90%) from rent. When people invest in an REIT, they become shareholders, earning a portion of the rental income the company generates from its properties.
In turbulent economic times, having dependable passive income can provide a measure of security. REITs offer a good option to actively generate passive income.
What is Passive Income?
Before you jump into your first REIT investment, it’s important to understand how passive income works. As Kiplinger says, it’s money you make “without a large amount of additional work added to your day-to-day routine.” The goal? Creating a “side” income source that complements the regular income generated from your job or other places. With passive income, you:
- Gain financial stability and freedom
- Reduce reliance on your paycheck
- Increase your ability to meet financial goals more easily
- Potentially set yourself up for earlier retirement
Enter REITs. Nerdwallet suggests that “[n]ew investors may want to stick to publicly traded REITs which you can purchase through a broker.” But another option is diversifying through mutual funds or exchange-traded funds (ETF) tracking multiple REITs.
Advantages of Investing in REITs
There are some significant advantages to investing in REITs, including the high dividend yields, with the law requiring that REITs pay 90% of earnings to their shareholders. Anyone investing in an REIT will receive regular dividend payments.
Another advantage? They provide diversification for portfolios. By investing in an REIT, you gain exposure to the real estate market without having to own physical property — an especially useful approach for investors lacking time or resources to manage rental properties themselves or wanting to diversify their portfolios.
Experienced professionals manage REITs, handling day-to-day operations of the properties. This approach eliminates the need for investors to become “hands-on” with managing tenants or dealing with maintenance issues.
Because REITs are publicly traded on stock exchanges, investors have a liquid investment easily bought and sold.
Challenges of Investing in REITs
Investing in REITs does come with risks. Conduct due diligence to carefully consider the risks before signing a check. Because, like any investment, volatile market conditions can affect value, and there’s no guarantee you’ll earn a positive ROI, prepare for holding your investment for the long term.
REITs are also subject to interest rate and liquidity risks and other factors that can affect their performance, profitability, and payouts. And some REITs charge fees for management and administration, which can eat into investors’ returns.
Types of REITs
There are different types of REITs divided into two types. First are the equity REITs, which own stakes in the real asset directly, managing it, collecting rents, and maintaining property. Second are the mortgage REITs, which own mortgages on the assets and collect interest or payments on the property’s financing. Like typical homeowners, they borrow money to purchase their properties — but a steady cash flow from rents or other payments enables them to safely borrow substantially.
- Private REITs aren’t registered with the U.S. Securities and Exchange Commission (SEC) and aren’t traded on the exchanges. They’re sold only to institutional investors (think accredited investors or large pension funds) with net worth of greater than $1 million or an annual income over $200,000. These REITs have a minimum investment between $1,000 and $25,000.
- Non-traded REITs are registered with the SEC but don’t trade on the major exchanges. Their registration requires that they file quarterly and year-end financial disclosures.
- Publicly traded REIT stocks are registered with the SEC and traded publicly. Many experts consider them superior to non-traded and private REITs because they’re subject to investor oversight and disclosure, and they have better corporate governance.
- Publicly traded REIT funds are similar to publicly traded REIT stocks but these funds include all equity REIT sub-sectors like commercial, lodging, towers, and others. Buying these funds give investors the REIT advantages without exposure to risks inherent in individual stocks through diversification.
- REIT preferred stock behaves more like a bond than a stock. It pays out regular cash dividends and has a redeemable fixed par value. These REITs also respond to interest rates, where higher rates generate lower prices (and vice versa). Because these REITs don’t receive a stake in ongoing profits, they’re less likely to appreciate above their issue price.
Factors to Consider When Evaluating REITs
When you’ve decided it’s time to invest in an REIT, there are several factors to consider as you build — and then narrow down — your list.
- The quality of the underlying real estate assets: Look for REITs that own high-quality real estate assets in desirable locations. Consider, also, properties with strong occupancy rates and rental income growth potential.
- A strong management team: The management team’s experience and track record are crucial in evaluating an REIT’s potential. Look for experienced management teams with a strong history of executing successful real estate strategies.
- Dividend history and yield: While REITs are popular because of their high dividend yields, make sure to analyze each REIT’s dividend history and the sustainability of dividend payments.
- Financial position: An REIT’s financial position offers insight into its ability to weather economic downturns and other challenges. Look for REITs with strong balance sheets and adequate liquidity.
- Industry trends and macroeconomic factors: Interest rates, supply and demand dynamics, and regulatory changes can impact an REIT’s performance.
A Few REIT Caveats
It’s best not to look at REITs as an investment asset unto themselves. Instead, use the lens of industry trends to analyze the REIT most appropriate for your portfolio. Will an REIT heavily invested in malls make sense, or not — since mall traffic continues to decline with the huge popularity of online shopping?
What about hotels? The travel industry was hit hard by the 2020 pandemic and while it’s been recovering, the current economic turbulence has impacted businesses. Many corporate leaders have sought cost-cutting measures like reducing business travel and opting for web conferences instead of onsite conventions and gatherings.
REITs operate across many diverse sectors, from healthcare, data centers, and lodging to apartments, retail, and many others. A one-size-fits-all approach doesn’t work, because each sector’s dynamic is so very different.
Overall, REITs offer a solid option for people looking for passive income from real estate investments. Identifying the best REITs that align with investment objectives and risk tolerance requires careful research and due diligence.
Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.