In most cases, the easiest and most direct way to invest in a real estate asset is to purchase a property. While this approach can yield excellent returns and important tax benefits, not all real estate investors have the time, expertise, and resources needed to purchase a property directly. For these investors, fractional ownership of a commercial property may be a compelling option and one of the ways this is accomplished is through the purchase of shares in a Real Estate Investment Trust – REIT for short.
In this article, we will provide a guide to investing in REITs. We will describe what they are, how to invest in them, the benefits and risks of doing so, and how they compare with the types of private equity syndications that we offer. By the end, readers will have a thorough understanding of REITs and will be able to determine if investing in one is a good fit for their own investment objectives.
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What is a REIT?
REIT is the acronym for Real Estate Investment Trust which is a specialized type of investment vehicle. How a REIT works is individual investors purchase a fractional share of a portfolio of commercial real estate assets. They can be privately held or publicly traded and often specialize in a particular asset class. For example, some REITs may invest in retail properties while others may concentrate on office buildings or multifamily apartment buildings.
There are four types of REITs:
- Equity REITs: Most REITs are equity REITs and they offer an equity ownership stake in a diversified portfolio of commercial real estate properties. In return, investors receive their pro rata share of the cash flow and profits produced by the underlying assets. Again, equity REITs are likely to specialize in a specific asset class like shopping centers, data centers, self storage or senior living facilities.
- Mortgage REITs: mREITs for short, mortgage REITS provide financing for the purchase of real estate assets. They are more commonly associated with residential mortgages than commercial ones, but they can originate loans for any type of income producing property.
- Public Non-Listed REITs: Public, non-listed REITS are registered with the securities and exchange commission (SEC), but not traded on public exchanges. They may also specialize in certain asset classes, but they do not have a high degree of liquidity since they cannot be bought and sold on public exchanges.
- Private REITs: Private REITs are exempt from SEC registration requirements as long as they comply with a certain set of rules, most notably they can only sell shares to accredited investors. Likewise, they do not trade on public exchanges, which means that they are far less liquid than their publicly traded REIT counterparts.
The vast majority of individual investors are likely to direct their capital towards equity REITs so they will be the focus of the remainder of this article – the terms “REIT” and “Equity REIT” will be used interchangeably.
How to Invest in a REIT
The mechanics of making a REIT investment depend on whether the REIT is publicly traded or privately held.
If the REIT is publicly traded, shares can be bought and sold on public exchanges by anyone with a brokerage account – much like an exchange traded fund (ETF). For example, Prologis is one of the largest publicly traded REITs in the US and they specialize in warehouse and logistics facilities. Their shares trade on the New York Stock Exchange (NYSE) for ~$120 each at the time of writing.
If the REIT is not publicly traded, shares can be a bit more difficult to purchase. First, they are only available to accredited investors and often come with minimum investment requirements in the $25,000 – $50,000 range. Often, non-publicly traded REIT shares must be purchased directly from the REIT or through their broker-dealer network.
In most cases, individual investors will opt for publicly traded REITs, but there may be certain circumstances where a non-publicly traded REIT may be a good fit.
Requirements to Invest in REITs
Again, the requirements for investing in REIT shares depend on if they are publicly traded or not.
There are virtually no limitations on the purchase of publicly traded REIT shares. All an investor needs is a brokerage account and at least enough money to purchase one share – usually around $100.
For non-publicly traded REITs, the requirements are a bit more cumbersome. First, investors must be accredited – which means that they have to meet certain income and/or net worth requirements. Second, investors must have enough capital to meet the minimum investment requirement – usually $25,000 – $50,000. Finally, investors must sign a significant number of documents indicating that they understand the risks and complexities of purchasing non-publicly traded securities.
Risks and Benefits of Investing in a REIT
Like every investment opportunity, there are both risks and benefits to making a REIT investment. They are generally the same whether the REIT is publicly traded or privately held.
REIT Benefits
There are many benefits to investing in a REIT, but the most notable include:
- Dividend Income: Under IRS rules, REITs are required to pay out a high percentage of their income and profits in the form of dividends. So, they can be an excellent way to earn passive income from high dividend yields. However, it should be noted that REIT dividends received are taxable income and subject to income tax. They must be accounted for as such.
- Diversification: The purchase of one REIT share provides investors with exposure to a diversified portfolio of professionally managed assets. In addition, buying REIT shares provides additional portfolio level diversification away from the standard stock/bond/mutual fund split. In both cases, this type of diversification reduces risk for investors.
- Taxes: As long as REITs follow the rules laid out by the IRS, they are not taxed at the entity level. Instead, the income and profits are passed through to shareholders, where they are taxed at the individual level. Avoiding double taxation can help drive higher returns for investors.
- Liquidity: With regard to publicly traded REITS, they are liquid. They can be bought and sold at will, providing investors with a high degree of liquidity that isn’t normally available in a direct property purchase scenario.
- Time: REIT assets are professionally managed by a third party firm, which reduces/eliminates the time that must be spent on things like negotiating leases, managing accounts payable, or collecting rent. This allows individuals to get their time back and spend it on things they enjoy like their family or traveling.
- Fractional Ownership: Buying REIT shares provides REIT investors with fractional ownership of a portfolio of real estate assets. Thus, investors are entitled to their pro rata share of the rental income and capital gains produced by the portfolio. These can drive total returns for an entire investment portfolio.
There is no doubt that, in the right circumstances, a REIT investment can be a good choice for an individual investor looking for exposure to different types of real estate.
REIT Risks
REIT benefits must be weighed against REIT risks, which may include:
- Volatility: Share prices in publicly traded REITs can experience periods of significant volatility – along with the stock market – even if there is no change to the fundamentals of the underlying portfolio. For many investors, these periods can test their nerves, but they should remember that these movements tend to be cyclical and will eventually move the other way. This is why REITs should be considered a long term investment.
- Control: REIT investors have no control over the management of their assets. They have no say in when to buy or sell or what rent to charge or how much to place in operational reserves. Some investors may not like this and prefer to control things themselves.
- Interest Rates: REITs use debt to purchase their assets and work with a wide group of lenders to source it. Depending on the structure of their debt (e.g. fixed rate vs. variable rate, short term vs. long term), REIT share prices can be very sensitive to movements in interest rates – especially when they go up.
- Tenant Risk: The entire REIT investment strategy is predicated upon the idea that tenants will continue to pay their rent every month. So, whether dealing with an office REIT, healthcare REIT, retail REIT, or residential REIT, gross income is derived from tenant rental payments. When tenants decide to vacate their space or go out of business, the REIT’s income can be reduced and, if enough tenants stop paying rent, so can their dividends.
- Market Risk: Real estate markets are dynamic. They go up and down in response to macroeconomic conditions. These changes can impact property values and investment returns.
Investors should weigh the risks against the benefits to determine if a REIT investment is the right fit for their own individual needs.
So, Are REITs a Good Investment?
Given the risks and benefits, it is only logical to ask…are REITs a good investment? The short answer is, they certainly can be. But, it depends on a number of factors that are unique to each individual including time horizon, risk tolerance, investable capital, and total assets.are REITs a good investment
For investors with a small to medium risk tolerance, a long term time horizon, plenty of investable capital, and a desire to have passive involvement in their investment, REITs may turn out to be a great investment.
But, for investors with small risk tolerance, a short term time horizon, and immediate to intermediate liquidity needs, a REIT may not be a good fit for their needs.
So, each investor must do their own due diligence on their needs and strategy to determine if a REIT is the right fit for their own needs.
Investing in a REIT vs a Real Estate Syndication
A REIT is not the only way to gain fractional ownership of commercial real estate assets. Another common way is to invest in a real estate syndication – which is the type of investment opportunity that we typically offer.
In many ways, the types of syndications that we offer are similar to a REIT, but there are a few key differences:
- Syndications are not publicly traded. They are privately held investments that are subject to the same type of liquidity constraints as a privately held REIT.
- Our syndications are for one property, whereas shares in a REIT are for an entire portfolio of assets. There are both pros and cons to this type of strategy.
- Returns from a syndication are split with the transaction sponsor based on the performance of the property. This helps incentivize the transaction sponsor to drive returns and capital appreciation.
- Syndicated deals are available to accredited investors only. Thus, they must meet certain income or net worth requirements.
- Finally, since syndicated investments are not publicly traded, they cannot be purchased on an exchange. They are typically purchased directly from the syndicator or through the real estate companies that run them.
Investing in both a REIT or a syndication can yield a profitable outcome so real estate investors must determine which is the better fit for their unique circumstances. In general, syndications tend to be a better fit for high net worth investors who have a long term time horizon and a moderate risk tolerance.
Summary of REIT Investing
A Real Estate Investment Trust – REIT for short – is a special type of real estate company that owns, operates, and/or finances commercial real estate assets. They invest in all property types and in some cases mortgage backed securities.
Investors who like the REIT structure can purchase shares on a publicly traded exchange, from the REIT themselves, or through a broker-dealer network.
The benefits of a REIT investment include liquidity, diversification, and passive income in the form of high dividends.
The potential downsides of a REIT investment include market risk, tenant risk, lack of control, and illiquidity.
Investors should weigh the pros and cons of a REIT investment, along with their own personal preferences to determine if a REIT investment is a good fit for their own objectives.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and want to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
