by Ben Luxon July 31, 2019 6 min read

What is an REIT?

An REIT (Real Estate Investment Trust) is a portfolio of real estate set up and owned and run by a company. It allows individuals to buy shares in commercial real estate portfolios and receive income paid out as dividends. However, this isn’t an ordinary company share. 

REITs were first established in the US in 1960 and over the years have been recognized internationally as valid investment vehicles.

The properties that can be included in an REIT may include everything from apartment complexes to health care facilities, to infrastructure (cell towers, energy pipelines, etc.).  

Because of the broad array of potential real estate to invest in, most REITs specialize, focusing their time and energy on a particular segment. This allows them to maximize returns instead of spending all their time researching the vast horizon of real estate possibilities.

However, this isn't to say that REITs can’t be diverse, and specialty REITs often hold various types of property in their portfolios to mitigate potential risks associated with having too narrow an investment focus.

Don’t put all your eggs in one basket and all that.

Most REITs have a pretty straight-forward business model They invest in property or land and lease it out. They collect rent on the property and then distribute that wealth as dividends to their shareholders.

To qualify as an REIT, a company must oblige by a set of serious strict provisions.

  • Invest at least 75% of its total assets in real estate, cash or U.S. Treasuries
  • Receive at least 75% of its gross income from real property rents, interest on mortgages financing the real property, or from sales of real estate
  • Return a minimum of 90% percent of its taxable income in the form of shareholder dividends each year
  • Have a minimum of 100 shareholders after its first year of existence 
  • Have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year

Other requirements including the REIT be an entity that is taxable as a corporation in the eyes of the IRS. Further, the enterprise must have the management of a board of directors or trustees.

Should you invest in REITs

Why invest in REITs instead of directly in property?

There are a number of advantages to investing in an REIT which makes them very appealing as potential investments - at least on paper. Let’s dig a little deeper.

First, REITs are highly liquid. Whereas when you purchase a property it could take months, or even years to sell the property, with an REIT you can trade your shares on the stock market just like any other exchange-traded security.

As any homeowner can attest, illiquidity can be a real problem, especially if you need to get your cash out quick.

Second, as a pooled investment, you are buying shares in a diversified portfolio, not a single property. What this means is that risks are mitigated against the rest of the portfolio. If you invested in a single property all the risk would be associated with that single property. 

Thirdly, you can invest as much or as little as you want. When purchasing a property yourself there is a high monetary barrier to making that first investment which stops a lot of people from ever investing in the real estate market and getting the returns that that entails. With an REIT that barrier is removed. 

Finally, you don’t need expertise in planning, financing, development, maintenance or tenant management, that come with running a rental property or portfolio of rentals. 

Should you invest in REITs

Types of REITS

Not all REITs are the same. There are various classifications that indicate the type of business they do and can be further classified depending on how their shares are bought and sold.

Equity REITs 

This is the most common form of REIT. These buy, own and manage income-producing real estate. For example, revenues come primarily from rent rather than the reselling of the portfolio.

Mortgage REITs

These are known as mREITs. They lend money to real estate owners and operators and collect profits through interest returns. The lending may be either directly through mortgages and loans or indirectly through the acquisition of mortgage-backed securities (MBS). MBS are investments holding pools of mortgages issued by government-sponsored enterprises (GSEs). Due to the mortgage-centric focus of this REIT, they are potentially sensitive to interest rate increases.

Hybrid REITs 

Hybrids hold both of the aforementioned assets, both rental properties and mortgage loans. 

Publicly Traded REITs 

These REITs offer shares of publicly-traded REITs that list on a national securities exchange, where they are bought and sold by individual investors. They are regulated by the U.S. Securities and Exchange Commission (SEC).

Public Non-traded REITs 

Like the publicly traded REITs these are also registered with the SEC, but don’t trade on national securities exchanges. As a result, they are less liquid than publicly-traded REITs but tend to be more stable because they’re not subject to market fluctuations.

Private REITs

Last on the list are private REITs that are not registered with the SEC and don’t trade on national securities exchanges. They work solely as private placements selling solely to a select list of investors.

Pros and Cons of Investing in REITs

Pros

  • Liquidity
  • Diversification/Counterweight to other assets
  • Transparency
  • Steady dividends
  • Risk-adjusted returns

Cons

  • Low growth/Little capital appreciation
  • Non-tax-advantaged
  • Subject to market risk
  • High management and transaction fees

Should you invest in REITs

5 REITs to watch in the US

Vanguard Real Estate ETF (VNQ)

Courtesy of Vanguard

Vanguard is the largest mutual fund company around and continues to absorb funds at a rapid rate. Vanguard Real Estate ETF trades under the ticker VNQ and is commonly looked at as one of the best real estate ETFs available today.

With an expense ratio of just 0.12%, Vanguard claims its fee is 90% lower than the average real estate ETF. This REIT follows the MSCI US Investable Market Real Estate 25/50 Index. It is considered a little riskier than average, but not among the riskiest classes of ETFs.

Like most real estate funds, this fund got hammered in the real estate crash of 2007-2008, but it has offered steady and growing returns since. This is a great way to add real estate to a retirement account or other long-term investment account. Top holdings include Vanguard Real Estate II Index Fund, American Tower Corp, and Simon Property Group.

Schwab U.S. REIT ETF (SCHH)

Courtesy of Charles Schwab

Managed by Charles Schwab, the Schwab U.S. REIT ETF comes in as a close second to the best overall real estate ETF. Schwab is both a popular brokerage and fund provider and offers even lower fees than Vanguard’s competing fund.

This ETF follows the Dow Jones U.S. Select REIT Index and charges just 0.07% in fees. This ETF currently holds 116 assets, all based in the United States. This eliminates foreign real estate risk from your portfolio and is ideal if you want to focus on US real estate.

Major holdings include Simon Property Group, Prologis, and Public Storage. You’ll notice some overlap with the Vanguard fund above, but as they follow different indices they contain different assets.

iShares Global REIT (REET)

Courtesy of iShares

If you want to take your real estate investment dollars all over the world, the iShares Global REIT from Blackrock is a solid fund. This ETF has tended to outperform the benchmark FTSE EPRA/NAREIT Global REIT Index in the (less than) five years since the fund’s inception.

The iShares Global REIT ETF charges a competitive 0.14% management fee. Major holdings include Simon Property Group, Prologis, Public Storage, and Avalon Bay Communities. 

This fund is invested 65% in the United States, 7% in Japan, 6% in Australia, 5% in the United Kingdom, and the rest France, Canada, Singapore, Hong Kong, and South Africa with “other countries” making up 3% of total assets. These are generally developed, strong economies with stable real estate markets.

Fidelity MSCI Real Estate Index ETF (FREL)

Courtesy of Fidelity

Fidelity is another major ETF provider with a focus on U.S. real estate and among the lowest management fees around. You’ll pay a modest 0.084% expense ratio on this fund, which tracks the MSCI USA IMI Real Estate Index. 

Top holdings of this fund include American Tower Corp, Simon Property Group, Crown Castle International, Equinix, and Prologis. Simon Property Group shows up in most REIT ETFs that include the United States, as Simon Property Group is the largest retail REIT and largest shopping mall operator in the United States.

iShares Mortgage Real Estate ETF (REM)

Courtesy of iShares

This ETF from Blackrock includes exposure to U.S. residential and commercial mortgages. It is targeted to include domestic real estate assets including REITs, real estate stocks, and direct real estate investments.

This ETF is benchmarked against the FTSE NAREIT All Mortgage Capped Index and has slightly underperformed the index since inception. It had a lot of ground to cover as the fund’s inception date was on May 2007.

The fund charges 0.48% in management fees. Top holdings include Annaly Capital Management REIT, AGNC Investment REIT, New Residential Investment REIT, and Starwood Property Trust REIT.

We hope you found this blog interesting! However, do note that it should not be used as a substitute for competent legal and/or other advice from a licensed professional.

Ben Luxon

"Ben is a co-founder, author and real estate enthusiast. His interest in all things entrepreneurial has led him to work with real estate professionals all over the world, distilling their knowledge into articles and Ebooks. His love of travelling has taken him to over 10 countries in the last year, where he has sampled the craft beer of them all."


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