What is a REIT?

Background on REITs

A real estate investment trust, also known as a REIT, is a company that pools money from investors to buy, operate or finance revenue-generating real estate. REITs allow everyday people – not just banks and hedge funds – to earn money from real estate.

Through REITs, people can invest in real estate portfolios the same way they might invest in securities through a mutual fund. REIT investors earn a share of the income generated from the underlying real estate without having to deal with buying, managing or financing properties. REITs are a popular investment strategy. Approximately 170 million Americans have investments in REITs through mutual funds, exchange-traded funds or target date funds.

How do REITs work?

REITs invest in many different types of real estate from apartment and office buildings to warehouses, malls and hospitals. The majority of REITs specialize in a particular type of property, although some deal with multiple categories of properties. In the United States, REITs collectively own over $4 trillion in gross assets. Public REITs own more than $2.5 trillion in assets across 580,000 properties. U.S.-listed REITs have an equity market capitalization of over $1.3 trillion.

Advantages of investing in REITs

REITs were created in 1960 in the United States as an amendment to the Cigar Excise Tax Extension. This was the first time that individual investors could purchase shares in commercial real estate portfolios. Prior to the creation of REITs, only wealthy investors with the help of financial intermediaries were able to engage in this type of investing.

REITs provide a number of benefits to investors. Historically, REITs have delivered competitive returns thanks to long-term capital appreciation and high, consistent dividends. REITs can also be helpful for diversification. Additionally, because most REITs trade on public exchanges, they are relatively easy to buy and sell, especially compared to traditional real estate investments. REITS are not for everyone – although they provide benefits and potential competitive returns, they also have significant market risk and their investment is not guaranteed.

Disadvantages of investing in REITs

Like almost any investment, REITs also have their downsides. They do not offer as much capital appreciation as some investments, especially in the short term, because they are required to pay 90% of their income back to investors in order to avoid U.S. federal corporate income tax for the REIT. This means that generally at most 10% of taxable income is invested back into the REIT. REITs can sometimes have expensive management and transaction fees. Additionally, dividends from REITs are generally taxed as regular income.

As with any potential adjustment to your investment strategy, consider consulting a tax professional and/or financial advisor to see how investing in a REIT may impact your financial goals.

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