How to Invest in Real Estate Investment Trusts (REITs)

Introduction

Real Estate Investment Trusts (REITs) own, operate, or finance income-generating properties. They allow investors to pool their money to invest in real estate assets, such as commercial properties, residential properties, and mortgages. REITs must distribute a significant portion of their taxable income to shareholders as dividends, making them attractive for income-seeking investors.

Ways to Invest in REITs

Individuals can invest in REITs differently, depending on their preferences and financial goals. The most common methods include purchasing publicly traded REIT stocks, investing in Real Estate Investment Trusts, mutual funds, or exchange-traded funds (ETFs), and participating in defined benefit and contribution investment plans that include REITs.

Investing in Publicly Traded REIT Stocks

One way to invest in REITs is by purchasing shares of publicly traded Real Estate Investment trust stocks. These stocks are listed on major stock exchanges and can be bought and sold like any other public stock. This method allows investors to choose specific REITs based on their investment preferences and objectives.

REIT Mutual Funds and Exchange-Traded Funds (ETFs)

Investors can also gain REIT exposure through mutual funds and ETFs specializing in real estate investments. These funds pool money from multiple investors and invest in a diversified REIT portfolio. Investing in Real Estate Investment Trusts mutual funds or ETFs provides the benefit of diversification and professional management.

REITs in Defined Benefits and Defined Contribution Plans

REITs are increasingly becoming a part of defined benefit and contribution investment plans. Many Americans access REITs through mutual funds and ETFs in their 401(k)s, IRAs, the Thrift Savings Plan (TSP), and pension plans. Target date funds, prevalent in 401(k) plans, often include REIT allocations. Additionally, most pension plans, including those for teachers, firefighters, nurses, and state government employees, gain exposure to real estate through REITs.

Seeking Professional Advice

When considering investing in REITs, it is advisable to seek the guidance of a broker, investment advisor, or financial planner. These professionals can help analyze your financial objectives, risk tolerance, and investment horizon and recommend appropriate real estate investment trust investments. According to a 2020 Chatham Partners study, 83% of financial advisors recommend REITs to their clients.

Appropriate Allocation to REITs

Determining the appropriate allocation to Real Estate Investment Trusts in your investment portfolio depends on various factors, including financial goals, risk tolerance, and investment horizon. While there is no one-size-fits-all answer, several insights can help guide your allocation decision.

Optimal REIT Portfolio Allocation

Multiple studies suggest that the optimal Real Estate Investment Trusts portfolio allocation may range from 5% to 15%. David F. Swensen, noted CIO of the Yale endowment and author of “Unconventional Success: A Fundamental Approach to Personal Investment,” recommends a 15% allocation to REITs for most investors. Chatham Partners’ research found that financial advisors generally recommend grants to REITs from 4% to 12%, irrespective of the client’s age.

Age and Optimal REIT Allocation

Age can also influence the optimal allocation to REITs. According to the Morningstar Funds Management Glide Path Model, investors with a longer investment horizon may start with a higher percentage of REITs, which gradually declines as retirement approaches. For example, an investor with a 45-year investment horizon may have an optimal rate of 18% to REITs, which decreases to 3% at retirement and 2% after 15 years in retirement.

Assessing the Value of REIT Shares

The value of REIT shares is typically assessed by considering various factors that impact the investment value. Analysts evaluate anticipated growth in earnings per share, the expected total return from the stock, current dividend yields relative to other yield-oriented investments, management quality and corporate structure, and underlying asset values of the real estate, mortgages, and other assets.

Earnings and Dividend Measurements for REITs

Real Estate Investment Trusts use specific metrics to measure their earnings and ability to pay dividends. Generally Accepted Accounting Principles (GAAP) defines net income as REITs’ primary operating performance measure. Additionally, REITs use funds from operations (FFO) as a supplemental indicator of their operational performance. FFO excludes gains or losses from property sales and depreciation of property. Adjusted FFO (AFFO), another commonly used measure, adjusts FFO for rent increases and certain capital expenditures.

Factors Driving REIT Earnings Growth

Higher revenues, lower costs, and new business opportunities typically drive growth in REIT earnings. Key sources of revenue growth include increased building occupancy rates and higher rents. REITs also pursue additional property acquisition and development programs to create growth opportunities, provided the economic returns exceed the cost of financing.

Finding REITs

Finding REITs to invest in can be done through various resources. The REIT Directory, provided by Nareit, offers a comprehensive list of REIT and publicly traded real estate companies. The directory allows sorting and filtering by sector, listing status, and stock performance, making identifying Real Estate Investment Trusts that align with your investment criteria easier.

Tracking REIT Performance

Tracking the performance of REITs is crucial for investors. The FTSE Nareit U.S. Real Estate Index Series and the FTSE EPRA/Nareit Global Real Estate Index Series provide daily returns and insights into the performance of Real Estate Investment Trusts. Subscribing to updates from these indexes can help investors stay informed about the market trends and make informed investment decisions.

Tax Considerations for REIT Investments

Investing in real estate investment trusts may have tax implications that investors should know about. REITs must distribute at least 90% of their taxable income to shareholders as dividends, subject to taxation. Some REIT distributions may also be classified as ordinary income, qualified dividends, or capital gains, each with different tax rates. It is advisable to consult with a tax professional to understand the tax implications specific to your situation.

Conclusion

Investing in Real Estate Investment Trusts allows individuals to gain exposure to the real estate market and earn regular income through dividends. By understanding the different ways to invest in REITs, determining the appropriate allocation, assessing the value of REIT shares, and staying informed about market performance, investors can make informed decisions and potentially benefit from the growth and income opportunities offered by Real Estate Investment Trusts.

Remember to consult with a financial professional before making any investment decisions and consider your own risk tolerance and financial goals. Investing in Real Estate Investment Trusts can be valuable to your investment portfolio with proper research and due diligence.

FAQs

Q: Are REITs a surefire way to make money?

A: While REITs offer solid income potential, there are no guarantees in the financial Wild West. Do your homework and invest wisely.

Q: Can I lose money investing in REITs?

A: Absolutely. The value of your REIT shares can go up and down like a rollercoaster. That’s why they say, “Only invest what you can afford to lose.”

Q: Are REITs only for the big shots with loads of cash?

A: Not at all; REITs allow even the most minor investors to dip their toes into the real estate market. You can start with as little as a hundred bucks.

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