Real Estate Investment Trusts (REITs) have quickly become a staple in every investor’s portfolio. They are also increasingly popular among middle-class, retail investors due to their low barriers to entry and above-average returns. In this post, we’ll give you the information you need in order to decide whether adding REITs to your portfolio is the right choice for you.
What is a Real Estate Investment Trust?
A Real Estate Investment Trust or (REIT) is an entity that owns and operates income-generating real estate. This is usually done through real estate investment firms purchasing or leasing commercial or residential real estate, making income from the rent, then passing a portion of those profits on to those who assisted in essentially crowdfunding the project.
REITs first appeared when congress made an amendment to the Cigar Excise Tax Extension of 1960. This allowed individuals to purchase shares in commercial real estate portfolios and draw dividends from the profits. They give the everyday investor an opportunity to benefit from a small piece of the greater real estate market, without needing the capital to own property themselves. All of the research, investment, and energy spent making the project profitable are left up to the company managing the trust.
Popular Types of REITs
Equity REITs or EREITs are usually the most common. They are organizations that buy and manage income-producing real estate projects. The income is usually achieved through rent generated from the tenants. These can be divided between retail and residential properties. With a REIT heavily invested in retail properties, it’s important to properly vet their choices in tenants. If cash-flow becomes a problem for the retailer and the organization needs to find a new tenant, this could result in a slowdown in returns.
Mortgage REITs or MREITs are trusts that operate essentially as mortgage lenders. They offer real estate loans and generate income based on the interest generated through those loans. There are also Hybris REITs, that have a stake in both the equity and mortgage markets.
Publicly Traded vs. Public Non-Traded REITs
Publicly Traded REITs are regulated by the Securities and Exchange Commission (SEC) and shares are bought and sold by individual investors. Public Non-Traded REITs are registered with the SEC but are not traded publicly on exchanges, which will usually make them a bit less volatile since they are not subjected to the price swings of the general market.
Benefits of REITs
With the added risk of having to lock in your investment for the medium to long term, comes fairly high returns. The average annual return for all Fundrise investments assuming all dividends reinvested in 2017 was 11.44%. This can be highly lucrative for the savvy investor, and a great way to counterbalance your investments in stocks and bonds through a product with relatively low fees.
Drawbacks of REITs
Many of the larger companies like Fundrise are not publicly traded companies and therefore suffer from a lack of liquidity. This makes them a better bet for long-term investments. With Fundrise and some other similar companies, you might incur high early exit fees if you withdraw your funds in less than 5 years. These types of investments have also only become popular in the last few years and have not yet shown how they hold up in a significant real estate downturn.
To summarize, REITs have become a very popular addition to the average investor’s portfolio. Time will tell whether they hold up to all the hype. But if you weigh the benefits versus the risks, it very well might be a fruitful endeavor for you to add to your investment quiver.