Real estate investment trusts (REITs) are a popular investment option for individuals looking to diversify their portfolios and earn passive income. In this article, we will explore what REITs are, how they work, the different types of REITs, and the pros and cons of investing in them.
### What is a REIT?
Real estate investment trusts (REITs) are companies that own and operate income-producing real estate. Investors can buy shares in REITs, similar to stocks, and earn money through dividends. REITs typically own a variety of properties such as apartments, warehouses, self-storage facilities, malls, and hotels. Investors can purchase REITs through an investment account, also known as a brokerage account.
### How do REITs work?
Congress created REITs in 1960 to allow individual investors to own equity stakes in large-scale real estate companies. REITs are required to meet certain standards set by the IRS, including returning a minimum of 90% of taxable income to shareholders as dividends each year. By adhering to these rules, REITs do not have to pay taxes at the corporate level, allowing them to finance real estate more cheaply and earn more profit to distribute to investors.
### How much can I make with REITs?
When comparing potential returns, it can be helpful to look at benchmarks such as the S&P 500 and the FTSE NAREIT All Equity REITs Index. On average, REITs have returned a total annual return of 11.8%, outperforming the S&P 500. Investing in REITs can provide diversification to a portfolio and potentially higher returns.
### Types of REITs
REITs are divided into three broad categories based on their investment holdings: equity, mortgage, and hybrid REITs. Equity REITs own and operate real estate properties, while mortgage REITs own debt securities backed by real estate. Hybrid REITs combine elements of both equity and mortgage REITs. Each type of REIT has different characteristics and risks, so it is essential to understand them before investing.
### Pros and Cons of REITs
Investing in REITs offers several advantages, including steady dividends, high returns, liquidity, and lower volatility compared to traditional stocks. However, REITs also have drawbacks, such as heavy debt, low growth potential, tax burdens, and illiquidity, especially for non-traded and private REITs.
### Investing in REITs: How to get started
To invest in REITs, individuals can open a brokerage account and purchase publicly traded REITs like stocks. Alternatively, investors can buy REIT ETFs or mutual funds for instant diversification and lower risk. Keeping REIT investments in a tax-advantaged account like a Roth IRA can provide tax benefits.
In conclusion, REITs are a valuable investment option for individuals seeking exposure to the real estate market and passive income through dividends. By understanding the different types of REITs, their pros and cons, and how to invest in them, investors can make informed decisions to enhance their investment portfolios.