How to invest in real estate investment trusts (REITs)

A real estate investment trust (REIT) is a great way to start real estate investing with limited funds.

Real estate investment trusts are companies that finance, operate, or own real estate that generate income. If you invest in REITs, you are indirectly investing in a diversified portfolio of properties—minus the headache of property management.

In this article, we will clearly define real estate investment trust. We will also explain how they work and how you can start investing in one. Here is everything you need to know.

What is a real estate investment trust (REIT)?

Within the world of real estate investing, real estate investment trusts are growing in popularity for investors who want to expand their portfolios beyond mutual funds or publicly traded company stocks.

A real estate investment trust is a company that owns and usually operates income-generating real estate. That real estate can include apartments, self-storage facilities, hotels, warehouses, and malls.

Why are REITs so appealing? It is simple. The more reliable real estate investment trusts are proven in paying large—and growing—dividends. Depending on the type of REIT, however, that potential for growth still comes with risk.

Real estate investment trust: how they work

In 1960, Congress created real estate investment trusts. It was a way for individual investors to own equity stakes in large-scale real estate companies, like owning stakes in other businesses. The creation of REITs made it easy for investors to purchase and trade diversified real-estate portfolios.

Real estate investment trusts are required to meet a set of standards created by the Internal Revenue Service (IRS). A REIT must:

• Have no more than 50% of shares held by five or fewer people during the second half of the taxable year;
• Have a minimum of 100 shareholders after the first year;
• Invest a minimum of 75% of total assets in cash or real estate;
• Receive a minimum of 75% of gross income from real estate, including real property rents, interest on mortgages financing the real property, or from real estate sales; and
• Return at least 90% of taxable income in the form of shareholder dividends every year—which is a major draw for investor interest in real estate investment trusts.

By adhering to the IRA’s standards, real estate investment trusts can avoid paying tax at the corporate level. That allows REITs to finance real estate more cheaply compared to non-REIT companies. This also allows them to earn more profit to disburse to investors. In other words, real estate investment trusts can, over time, grow in both size and dividends.

Real estate investment trust: different types

Real estate investment trusts come in three basic categories:

• Equity REITs
• Mortgage REITs
• Hybrid REITs

Let’s look more closely at each.

Equity REITs

Equity REITs operate like a landlord. They handle all of the management tasks you might typically associate with owning a property.

Equity REITs own underlying real estate, provide upkeep, collect rent checks, and re-invest into the property.

Mortgage REITs

Mortgage REITs differ from equity REITs in that they do not own the underlying property. Mortgage REITs instead own debt securities backed by the property.

For instance, a family takes a mortgage out on a house. That type of REIT may purchase that mortgage from the initial lender and collect monthly payments over time. That would then generate revenue through interest income. The family, in this example (i.e., someone else) would own and operate the property.

Mortgage REITs are typically riskier than equity REITs. However, they also tend to pay out higher dividends.

Hybrid REITs

Hybrid REITs are exactly what the name suggests. They are a combination of both equity REITs and mortgage REITs. The business owns and operates the real estate property. They also own commercial property mortgages in their portfolio.

Real estate investment trusts: how to invest

Investing in a real estate investment trust is relatively straightforward. Getting started is as easy as opening a brokerage account. Both only usually take a few minutes. Just as you would any other stock, you will then be able to buy and sell publicly-traded real estate investment trusts.

Remember: REITs pay large dividends. It would therefore be wise to keep them inside a tax-advantaged account, such as an IRA. That way, you can defer paying taxes on any distributions.

If that's not for you, you can purchase a mutual fund or ETF that vets and invests in a range of real estate investment trusts on your behalf. That way, you get lower risk and immediate diversification. Most brokerages offer these types of funds. And compared to individual REITs, investing in them requires less legwork.

Is a REIT a good investment?

Investing in a real estate investment trust is a great way to diversify your portfolio outside of more traditional stocks and bonds. REITs are especially appealing for their long-term capital appreciation and their strong dividends.

All types of real estate investment trusts have their own benefits and risks. It usually depends on the state of the overall economy. As mentioned, investing through a REIT ETF is a good way for shareholders to engage with the sector without having to deal personally with its complexities.

What does a real estate investment trust do?

A real estate investment trust is a security that trades like a stock on the major exchanges and owns and (usually) operates income-generating real estate. Most REITs are registered with the Security and Exchange Commission (SEC) and are publicly traded on the stock exchange. These are known as publicly traded REITs.

What is the problem with real estate investment trusts?

One problem with real estate investment trusts is the market risk. REITs are traded on major stock exchanges and are subject to price fluctuations in financial markets. If they sell their shares on the public exchange, investors might receive less than they originally paid for.

Are REITs riskier than stocks?

Typically, no. REITs are not riskier than stocks. While investing in real estate investment trusts does, data shows that REITs are not as risky as stocks both in the long term and in the short term. As with anything, past performance does not necessarily mean future performance. Even with this in mind, however, it remains promising for would-be investors of real estate investment trusts.   

Investing in a real estate investment trust can mean apartments.

Real estate investment trust: closing thoughts

Investing in real estate investment trusts can be highly lucrative. The more reliable real estate investment trusts are proven in paying large—and growing—dividends.

This does not mean, however, that they come with zero risk. Investing in an REIT still means that you are at the mercy of the wider financial markets. To ensure you invest successfully, remember to conduct your own research to go into it with as much knowledge as possible.

If you're truly interested in real estate investment trusts or want to learn more about where best to invest from someone in the industry, take the time to look at the mortgage professionals we highlight in our Best of Mortgage section. Here you will find the top performing mortgage professionals, including mortgage brokers, across the USA.

Did you find these tips on real estate investment trusts useful? Have you recently begun your own journey into REITs? Let us know in the comment section below.