If you’re looking to add real estate to your investment portfolio without the added hassle of managing properties, maintenance and vacancies, an equity REIT might be the answer. Equity REITs let you invest in a variety of different properties, earn passive income and further diversify your portfolio to protect its growth. But how do equity REITs actually work and are they really worth buying? Here’s what you need to know. Check in with a financial advisor to make sure your real estate investing is a good fit for your goals, risk profile and timeline.
What Is an Equity REIT?
When most people think of a REIT, or real estate investment trust, they are often thinking of an equity REIT.
Equity REITs are real estate-based companies that own and manage various types of real property. They do this by pooling together many different investors’ funds. Equity REITs are different from mortgage REITs (or mREITs), which provide asset-based funding (i.e., mortgages) for real estate projects.
According to the SEC, REITs are required to invest least 75% of all assets in various real estate assets and cash. They must also derive at least 75% of their gross income from real estate-related sources, such as rental income.
These REITs may build or purchase:
single- and multi-family residential homes
industry parks and warehouses
hotels and motels
hospitals, clinics and medical centers and more
Often, REITs will maintain and manage these properties, generating regular income through rental payments. Down the line, the REIT may choose to sell certain properties, generating additional income via the gains from those sales.
By buying into an equity REIT, investors can not only diversify their portfolio but also invest in real estate without the day-to-day hassles involved with investment property management.
How Equity REITs Work
Equity REITs operate similar to a mutual fund, in that investors can purchase shares of a REIT. This allows them to invest in a variety of different real estate ventures at one time without worrying about vacancies, repairs or things like property taxes.
The REIT manages the ins and outs of each property, including tenants and maintenance. As these properties receive income — from things like rent payments, gains on the sale of property and mortgage interest charges — investors will be sent scheduled dividend payments.
The SEC requires REITs to distribute 90% (or more) of their taxable income to shareholders each year. However, most REITs actually pay out 100% or more of their taxable income to shareholders, as a way of reducing or avoiding corporate taxes. Because of this, REITs can be a great source of passive income and investors can usually rely on the funds to be well-managed.
In the U.S., equity REITs play a significant financial role in the economy. According to industry leader Nareit, equity REITs currently own more than $2.5 trillion in real estate in our country. This total is spread across more than 500,000 different properties in all 50 states and Washington, D.C.
Pros of Equity REITs
There are few things to keep in mind if you’re considering adding equity REITs to your investment or retirement portfolio. For one thing, equity REIT dividends offer passive income streams. The dividends provided by equity REITs can offer investors a steady opportunity for passive cash flow, either before or during retirement.
REITS add diversification. Adding REITs to your portfolio can help diversify the investment held in a portfolio. This allows investors to hedge their overall investments against market downturns and potential losses.
Real estate helps hedge against inflation. The money in your retirement account may not go as far in 20 years as it does today, thanks to inflation. Real estate, however, has a historical tendency of growth that matches or exceeds inflation, allowing investors to better protect their savings from depreciation.
REITs tend to perform well. According to Nareit, the FTSE All Equity REITs Index has managed to outperform the S&P 500 in 15 out of the last 25 years. This means that investors generally a capital appreciation that matches or often exceeds popular investment indices.
REITs are more liquid than private investment properties. Real estate is generally considered an illiquid asset. In order to pull funds from an investment property, one would need to take out a home equity loan (such as a HELOC) or even sell the property. Both of these can take time. REITs, however, are generally listed on major stock exchanges and can be sold rather easily.
Cons of Equity REITs
Investors have no control over the projects. Unlike purchasing and managing a rental property, you don’t have much control (or sense of ownership) over the investments chosen by a REIT.
There are fees involved. Investors can expect to pay management fees when investing in a REIT, which is often a percentage of the total investment held. These fees can add up over time and will impact your overall return.
Market fluctuations are possible. Depending on the types of investment property your REIT holds, trends and market volatility can impact their performance. A flooded rental market may result in higher-than-normal vacancies among apartment buildings and residential properties, for instance, reducing rental income.
Buying an Equity REIT
Adding equity REITs to your portfolio can be fairly simple.
Investors can purchase shares of publicly traded REITs through a broker or their everyday investment/brokerage platform. Non-publicly traded REITs can be purchased through an SEC-registered financial adviser or broker-dealer who participates in that investment’s offering.
There are also REIT exchange-traded funds (ETFs) to consider, as well as REIT mutual funds. The right real estate investment for you depends on your existing portfolio, preferences and your plans.
The Bottom Line
Equity REITs are one way to invest in real estate. They can provide cash flow, diversificaiton and a hedge against market downturns and inflation. Such REITS may buy and manage single- and multi-family homes, residential buildings, commercial complexes, storage units and office buildings. They can be publicly traded, privately traded and public non-traded equity REITs. Eligibility and minimum investment requirements vary; publicly traded equity REITs are generally the easiest and most affordable option for new investors. They let investors add real estate to their portfolio, without the hassle of buying property, making repairs or finding tenants.
Tips for Investing
Consider working with a financial advisor as you evaluate and update your portfolio’s asset allocation. Finding a financial doesn’t have to be hard. SmartAsset’s matching tool can connect you in minutes with a financial advisor in your area. If you’re ready, get started now.
One of the quickest ways to make sure you have a good balances of the various types of securities is using a free asset allocation calculator.
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