What You Should Know About Your REIT Investment

Real estate investment trusts or REITs can offer you the benefits of investing in real estate and the ease of putting money in publicly traded stocks.

In short, they let you enjoy the rewards of property investing in a more convenient and more liquid way.

No wonder REITs have been very popular with investors who appreciate this asset class's ability to deliver regular dividend-based income, transparency, inflation protection, liquidity, and portfolio diversification.

These trusts have become essential components of investment portfolios for those who are saving for retirement and retirees who need to establish a regular income stream for meeting their living expenses.‍

Are you thinking of investing in REITs? Here are the basics you need to know.

Access commercial real estate for less

One of the most incredible things about REITs is that they allow smaller investors to invest in assets that are otherwise too hard to reach, mainly commercial real estate.

Most people can’t purchase a class-A office tower, but REITs will allow them to do that.

You, too, can use REITs to own pieces of hundreds of apartment complexes, shopping malls, data centers, etc.

Excellent Diversifier

You’ve probably heard that investment portfolio diversification is always a good thing.

Introducing REITs into your mix can help you do that quickly and efficiently. Even though REITs are technically considered stocks, the property is technically a different asset class.

Real estate has also historically held its value better than equities during uncertain economies. Buying REITs can be an excellent way to add predictable and steady income to your investment portfolio.

Liquidity

It’s no secret that selling a piece of property for profit is hard work. You might be forced to sell for less if you need cash fast.

This is not a problem with REITs, which are too liquid investments. Sell or buy REITs whenever you want, wherever you want, with just a few clicks of a button. It’s easy to free up some of your money this way.

High Dividend Yields

Often described as total return investments, REITs typically deliver high dividends on top of capital appreciation potential.

‍Disclaimer: This list of some of the larger REITs is not intended to be an investment recommendation.

‍To put this in context, keep in mind that the average dividend yield S&P 500 stocks paid in the same year was only 1.9%.

Compare this to the average equity REIT that produces around 5% and the average mortgage REIT that pays about 10.6%, and you will quickly see that the difference is staggering.

You might be wondering: Why do REITs pay high dividends? There are two reasons why this happens.

• First of all, a REIT has to distribute at least 90% of its taxable income to its shareholders every year. A stable stream of income from rent paid by tenants fuels these dividends. In reality, however, most REITs pay out 100% or even more. Does this sound unsustainable? Don’t worry—it’s quite the opposite. Investors have to keep in mind that ‘taxable income’ does not accurately represent how much a REIT earns. For example, a company can write off property investments for tax purposes over a certain number of years in a process called ‘depreciation.’ This depreciation doesn’t cost anything even though it lowers the taxable income of the REIT. What you should be looking at is the FFO or ‘funds from operations.’ This metric adds depreciation into the equation in just a few more factors to present a more accurate picture of what a REIT makes. Let’s say that a REIT earns a $1-per-share taxable income, and its FFO is $2.50. That REIT can pay out dividends of $2.00 per share—this is not unusual. Payouts of 70% to 80% of the FFO, regardless of taxable income, is the industry average.

• The second reason why REIT dividends are so high is that REITs don’t pay corporate taxes. Aside from the fact that REITs have to distribute almost all taxable income, they are not taxed on a corporate level. Imagine that a REIT earns $100 million in taxable profit. This means that it is required to payout at least $90 million to its shareholders. In contrast, a non-REIT company that also earns $100 million has to pay a 21% corporate tax rate, leaving $79 million after taxes. If this company wanted to payout 90% of its shareholders' profits, that 90% would only translate to $71 million less. That’s nearly $20 million less than the REIT.

A close look at mortgage REITs

Mortgage REITs are incredibly lucrative and attractive to certain types of investors because they can offer advantages that equity REITs cannot.

To be clear, equity REITs owned properties while mortgage REITs own mortgage-backed securities and other such related assets. The latter tend to pay higher dividends. Here’s why.

Equity REITs combine income and stock price appreciation because commercial properties produce rental income to increase in value over the long term.

Mortgage-backed securities, on the other hand, are purchased solely for payment.

This enables mortgage REITs to produce the maximum income amounts within specific risk parameters, with little regard for potential asset appreciation.

Tax implications of investing in REITs

Do note that REIT dividends are subject to unique tax implications. Most REIT distributions fall under ‘ordinary income,’ so they may be taxable at the investor’s marginal tax rate. This is something to consider when thinking about investing in this asset class.

Should you invest in REITs?

Real estate—which has been the best performing investment class in modern history—has long been considered a playground for the wealthy and well connected because it benefits from a set of advantages not available in other investments.

REITs have essentially democratized real estate investing, causing those barriers to come crashing down.

Nowadays, even smaller investors can build real wealth using REITs—at a fraction of what it would traditionally cost to invest in this asset class.

The advantages of property investing are now available to anyone. These instruments have consistently provided competitive returns based on long-term capital appreciation and steady dividend income.

The comparatively low correlation of real estate with other asset classes also makes REITs an excellent portfolio to diversifiers that can potentially help you reduce your overall portfolio risk while increasing your returns.

Their total long-term returns are similar to levels delivered by value stocks.

Al in all, REITs are worth looking at if you want to diversify your portfolio and put some money into the property industry without actually having the burden of owning and managing real estate assets.