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  • Writer's pictureKen Holman

What Are Real Estate Investment Trusts (REITS) and How Do They Work?

Updated: May 30


Coins and a house

According to the National Association of Real Estate Investment Trusts (NAREIT), Real Estate Investment Trusts (REITs) are companies that own or finance income-producing real estate across a broad range of property sectors. These real estate companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges and they offer a number of benefits to investors.


Like a mutual fund, REITs provide an investment opportunity for retail investors and institutions to benefit from companies that own real estate. It provides access to dividend-based income and total returns. REITs allow anyone to invest in a portfolio of real estate assets similar to how investors invest in other industries through mutual funds or exchange traded funds (ETFs).


What are the different types of REITs?


There are basically three different types of REITs: Publicly-traded REITs listed on one of the major stock exchanges; Public Non-listed REITs; and Private REITs. REITs can be further classified as Equity REITs or Mortgage REITs.


The vast majority of REITs are publicly-traded equity REITS. They own and operate income-producing real estate. The market generally refers to Equity REITs simply as REITs. Mortgage REITs (sometimes referred to as mREITs) provide financing for income-producing real estate by originating or purchasing mortgages and mortgage-backed securities and then distributing the income earned from the interest paid on these investments.


Public, non-listed REITs (PNLRs) are registered with the SEC but do not trade on the national stock exchanges. Private REITs are offerings that are exempt from SEC registration and whose shares do not trade on the national stock exchanges.


What assets do REITs own?


Collectively, REITs own more than $4 trillion in gross assets across the U.S., with public REITs owning approximately $2.5 trillion in assets. Exchange-listed REITs have an equity market capitalization of more than $1.2 trillion.


REITs invest in a wide range of real estate property types. Listed REITs are categorized into one of 14 property sectors: Office, Gaming, Industrial, Retail, Lodging/Resorts, Residential, Timberland, Health Care, Self-Storage, Telecommunications, Data Centers, Diversified, Specialty, and Mortgage REITs.


U.S. public REITs own an estimated 575,000 properties and 15 million acres of timberland across the U.S. Most REITs focus on a particular property type but some REITs hold multiple types of properties in their portfolios.


How do REITs make money?


REITs lease space and collect rent on the real estate it owns. As the company generates income, they are required by law to pay out at least 90% (most pay out 100%) of their taxable income to shareholders in the form of dividends. Like stocks, shareholders are required to pay income taxes on the dividends they receive. However, unlike stocks, REITs usually pay out a significantly higher dividend.


Why invest in REITs?


Historically, REITs have delivered competitive total returns based on high, steady dividend income and long-term capital appreciation in the value of the assets they hold. When it comes to diversification, which is an important fundamental principle when it comes to reducing overall portfolio risk and increasing long-term returns, REITs are an excellent portfolio diversifier due to their comparatively low correlation to other assets.


How have REITs performed in the past?


Over the past few years, with interest rates on the rise, REITs have not performed as well as Large-Cap and Small-Cap stocks but over the past 25 years, they have outperformed most other asset classes. See table below:


 

1-year

3-year

5-year

10-year

15-year

20-year

25-year

FTSE1 Nareit All Equity REITs

-1.71

2.68

2.79

6.17

6.11

7.90

8.62

FTSE EPRA/Nareit Developed2

2.72

1.53

-0.30

2.97

4.43

6.46

7.42

Russell 1000 (Large-Cap Stocks)

21.19

9.53

9.63

11.63

11.26

9.79

8.08

Russell 2000 (Small-Cap Stocks)

8.93

7.16

2.40

6.65

8.13

8.13

8.00

Bloomberg Barclay US Aggregate Bond

0.64

-5.21

0.10

1.13

2.53

2.85

3.59


1FTSE, now known as the FTSE Russell Group, stands for the Financial Times Stock Exchange which is a British financial organization that specializes in providing index offerings for the global financial markets.


2FTSE EPRA/NAREIT refers to the Global Real Estate Index Series designed to track the performance of listed companies and REITs worldwide. The series acts as a performance measure of the overall market and is also used as the basis for investment products such as derivatives and Exchange Traded Funds (ETFs).

 

How to invest in REITs


Any individual may buy shares in a REIT just like any other public stock listed on one of the major stock exchanges. Investors may also purchase shares in a REIT mutual fund or exchange-traded fund (ETF). Investors also have the ability to invest in Public Non-listed REITs and Private REITs, although they are more difficult to find.


If you need help determining which REIT is best for you, you should contact a broker (registered representative), investment adviser (investment adviser representative) or financial planner who can help you analyze the merits of a particular investment based on your financial objectives.

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