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REIT School

So, you’re interested in adding some real estate exposure to your investment portfolio? Then you’ve come to the right place. Today we’re going to talk about everything REITs and everything you need to know about buying them.

REITs - or Real Estate Investment Trusts - have been around since 1960 when the U.S. Congress established them as a way to give all investors, and especially small investors, a way to access income-producing real estate assets.

Buying and holding real estate is an investment as old as time. To this day, many of the wealthiest people and companies in the world have made their fortunes through real estate.

However, physical real estate assets like apartment complexes or commercial office buildings have high cash barriers to entry.

This is where REITs come in.

And while REITs are not the same as owning physical property, they have similar benefits including cash flowing income and capital appreciation. But more on this later.

The purpose of this article is to provide you with an in-depth guide about REITs and how to buy them. It’s a crash course in REIT investing and everything you need to know to get started.

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Account Minimum Investment: $500

Fees: 1%/year

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What is a REIT?

Real Estate Investment Trusts, otherwise known as a REITs, are companies that own or finance income-producing real estate in a range of property sectors.

They were established as a way to provide individual investors with a way of accessing and investing (buying shares) in commercial property portfolios.

Commercial properties like apartment buildings and shopping centers require a significant amount of capital to invest in.

More capital than a majority of investors and individuals like you and I have lying around in our bank accounts.

So REITs were established.

Picture it like this:

Company ABC is a real estate firm that buys and holds onto major apartment buildings and malls across American cities.

These assets generate rental income from the tenants and also appreciates - or increases in value as your home does - over time.

Company ABC wants more money to buy more assets, so they become a Real Estate Investment Trust which allows you and I to invest in them.

Company ABC then uses this money to purchase new assets. Because you and I invested in them, Company ABC is required by law to return 90% of it's taxable income to shareholders (me and you!) in the form of dividends each year.

To be classified as a REIT, a company must meet a few requirements:

  • Invest at least 75% of it's total assets in real estate and cash.
  • Receive at least 75% of it's gross income from real property rents, interest on mortgages financing the real property, or from sales of real estate
  • Return a minimum of 90% of its taxable income in the form of shareholder dividends each year
  • Be managed by a board of trustees
  • Have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year

How to Invest in REITs

When you invest in a REIT, you are investing in a company that owns real estate assets. This differs from buying a physical property on your own.

The primary difference is that the REIT is the physical owner of the property. They own the assets, they manage (or hire someone to manage) the properties, and they earn the income generated from said assets.

They also hold all of the mortgages and debt associated with the real estate.

But, as mentioned, when you invest in a REIT, they are required to return 90% of their taxable income to you. This is how you make money when investing in REITs.

Besides the distinction of owning physical property and owning shares in a REIT, there is another real estate investment option in the form of a REIT Fund.

A REIT is a single company that owns real estate. A REIT Fund is similar to a mutual or index fund in that it owns multiple REITs at once.


The benefits of a REIT fund come down to simplicity and diversification. A single REIT exposes you to only what that REIT holds.


With a fund, you are able to buy multiple REITs at once, diversifying your REIT investment instantly with one purchase. 

REIT funds come in many forms, but the most popular are REIT index funds or REIT ETFs.

REIT funds like this track a specific market index by holding hundreds of REITs at once and are typically low-cost options.

This simplifies the process for investors who are not interested in overly sophisticated REIT investing and research.

Why Should You Consider Adding REITs to Your Portfolio

Investing in REITs is a way to expose yourself to real estate without actually needing to buy and manage a property.

Adding REITs to your portfolio has three primary benefits.

Diversification

Diversification of your investment portfolio is fundamental to smart investing.

One of the most common forms of investment diversification is owning both stocks and bonds.

Because stocks and bonds function in different ways and react differently in the market, they provide growth potential (stocks) and downside prevention (bonds) when combined in a portfolio.

Real estate, and specifically REITs, offer a similar form of diversification within your portfolio. 

As they say, don’t put all of your eggs in one basket!

Dividends

REITs have historically been a reliable source of dividend income for investors. This is one of their primary attractions.

Because REITs are required to distribute 90% of their income in the form of shareholder dividends each year, the dividends end up being a large portion of a REITs total return.

On average, REITs have a yield of 4% whereas the S&P 500 yields around 2%.  

Who Should Invest in REITs?

The short answer is anyone who is interested in adding real estate to their portfolio, but does not want to, or does not have the cash available to, own physical property.

The longer answer involves looking at three broad age groups.

Young investors (age 20-40)

You’re young and you have plenty of time until retirement. Investment advice will almost always steer towards a more aggressive investment approach at this age.

Heavy stock percentages ranging from 70-100%, and bond percentages from 0-30%. Adding REITs to your portfolio helps diversify your investments and leans into the aggressive approach if you swap them with bonds.

At this age, the purpose of adding REITs to your portfolio is to diversify your investments, hunt for long-term growth and appreciation, and start building your annual dividend income.

Middle-aged investors (age 40-60)

By this age, you’re in the middle or nearing the end of your working career. Your investment portfolio may still lean towards growth but as you reach the end of this age range, it may start to take on less risk.

The purpose of adding REITs at this age is, again, to add diversification to your portfolio (diversification works at any age).

In addition to portfolio diversification, the dividend and income generation from REITs will establish itself as a mainstay in your portfolio and help prepare you for the next phase in life.

Retirement investors (age 60+)

The light at the end of the working-tunnel is very much in-sight or you’ve already reached it, and your portfolio reflects that.

It has somewhere between 40-60% in bonds with the remainder allocated to stocks.

At this age, REITs are most beneficial for their cash flowing properties.

With a sample portfolio of $1,500,000, a 10% allocation to a REIT ETF, and their historical yield of 4+%, your portfolio would be generating $7,500 in dividends annually from the REITs alone.

A Little More Technical Depth

Now that we have covered the basics of a REIT, including what a REIT is, how to invest in them, why you should consider adding them to your portfolio, and who should invest in them, it’s time to dive deeper into some of the more technical aspects of a REIT.

If the technical side of REITs doesn’t interest you, feel free to skip to the next section: How to Add REITs to Your Portfolio.

In this section, the guide reviews which type of investment account to use, it identifies a couple of industry standard REIT ETFs, and it covers REIT allocation within your investment plan.

The 3 Primary Types of REIT's

There are three primary types of REITs: equity, mortgage, and hybrid.

They differ in the way that they are structured but have similar income characteristics.

Equity REIT

Equity REITs are the most common form of REITs in the market.

These REITs offer people the opportunity to invest in income-producing real estate. When we discuss REITs, we are primarily talking about equity REITs.

Equity REITs are real estate companies that own or manage commercial properties.

After paying operating expenses, the remaining income that was generated from rents on these spaces is then passed on to the shareholders in the form of dividends (i.e. the 90% rule above).

Currently, equity REITs own more than $2 trillion of real estate assets in the U.S. including more than 200,000 properties.

Equity REITs can own a wide variety of commercial real estate from warehouses to hospitals, data centers to office buildings, apartment complexes to hotels.

Mortgage REIT

Mortgage REITs differ from equity REITs in that they earn income by purchasing or originating mortgages.

The interest on the mortgages turns into income for the mortgage REIT.

This structure is similar to how a bank makes money on any type of loan that they provide to their customers.

An interesting part of mortgage REITs is that they are not limited to commercial or income-  properties.

Mortgage REITs also purchase residential home mortgages.

Mortgage REITs rely on delicate interest rate trading, making them slightly more risky than equity REITs, but their dividends are often higher because of this.

Hybrid REIT

A hybrid REIT is just like it sounds: a hybrid - or combination - of equity and mortgage REITs.

Hybrid REITs combine the two primary types of REITs into a single offering.

Many times a hybrid REIT will be weighted more heavily toward one type of investment. 

A hybrid pairing offers the benefit of both styles of REIT.

REIT VS. Real Estate Crowdfunding

Real estate crowdfunding has become a popular source of real estate investment as technology has allowed regular investors access to this type of real estate transaction.

To understand how a REIT differs from crowdfunding, it’s important to understand what crowdfunding is.

The simplest example of crowdfunding is sites like Kickstarter or GoFundMe.

These sites ask large groups of people to invest in a business idea, non-profit, or other types of project.

Real estate crowdfunding functions in the same way.

If someone wants to invest in real estate but does not want to own or manage a property, or does not have the capital to buy one on their own, they can use a crowdfunding site to invest with smaller sums of money and less hassle.


The investors earn money from the profits of that specific venture. That could be from rental income, the sale of a new construction property, or sale of a rehabbed home.


If this sounds similar to a REIT, that is because it shares many of the same characteristics.

That said, the primary difference is that when you purchase a REIT you are purchasing shares in a company that owns multiple properties.

In the case of a REIT fund, you wind up purchasing shares in thousands of properties.

With crowdfunding, you are exposed to that single property you invested in. 

Crowdfunding is also not any type of stock, so it does not have the opportunity to be purchased and held over a long period of time. 

When a crowdfunding project ends, so does your investment in it.

How to Add REIT's to Your Portfolio

When it's time to add REITs to your investment portfolio, it’s important that you understand what kind of REIT you are buying, why you are buying it, and what types of investment accounts it should go in.

Retirement vs. Taxable Accounts

As with any investment, it’s important to pay attention to which account you are using to purchase shares of a REIT.

This is primarily due to the different tax treatments of each account.

The two primary types of accounts are Taxable (or Brokerage) accounts and Retirement accounts.

Taxable Accounts

Taxable accounts are your standard investment account that does not have any special tax treatment.

All deposits are post-tax and any income you earn from these investments are taxed as regular income or as long-term capital gains.

Retirement Accounts

Retirement accounts, like a 401k or IRA, do carry specific tax advantages that you’ll want to take advantage of.

This makes them the ideal candidate for REIT investments.

Breaking down retirement accounts a bit further, you have Traditional (pre-tax) accounts and Roth (post-tax) accounts.

All money invested in a Traditional 401k or IRA is done pre-tax, reducing your current taxable income.

When you withdraw this money in the future, you pay current tax rates on any investment gains you have earned over time.

With a Roth 401k or IRA, the money you invest is done post-tax.

This means you pay tax up front at the point of investment, and any investment gains you earn in the future are therefore tax-free.

Which Account to Choose

Recall that a primary benefit of REITs is their dividend yield, or income returned to shareholders in the form of dividends.

U.S. tax law classifies REIT dividends as ordinary income. This means that any income generated from a REIT will be taxed at your regular income tax rates.

Because of this type of tax treatment, Roth retirement accounts naturally make a good fit*.

Since all investment gains in a Roth account are tax-free when withdrawn, all of the income generated from a REIT is also tax-free.

Placing a REIT fund in your Roth 401k or IRA means you will only ever pay tax on the initial value of your investment, and never on any of the dividends or other investment gains that it produces.

*Please note: this is the author's OPINION and should not be taken as investment advice or any sort of recommendation. Please consult a certified investment professional for investment advice.

Two Great REIT Funds

We have talked a lot about how a REIT works and how to invest in them, but we have yet to talk about specific REITs.

The following are two industry standard REIT funds that provide excellent exposure at very low costs.

As stated above, the following is the opinion of the author, and should not be considered investment advice.

VNQ & FREL

In investment jargon, these are the “tickers” or investment symbols of the Vanguard Real Estate ETF (VNQ) and the Fidelity MSCI Real Estate Index ETF (FREL).

VNQ happens to be the largest and most popular REIT ETF in the world with $63.8 billion in net assets and holdings in 189 companies. Similarly, FREL has holdings in 179 companies.

In each case, the companies referred to are all REITs. These funds purchase shares of these REITs in order to provide a wide variety of diversification to their investors.

In addition to providing diversification, these ETFs offer exceptional expense ratios of 0.12% (VNQ) and 0.08% (FREL). This means an investment of $1,000 would cost you $12 and $8, respectively, to own.

High expense ratios are an investment killer, so finding investment options with low expenses can save you thousands.

Making Sure REITs Fit Your Investment Plan

It’s one thing to talk and learn about REITs, it’s another to buy them and make them a part of your investment plan.

Just like with any investment, you should make sure to know why you want to add REITs to your portfolio.

Take a birds-eye view of your investments and ask yourself these questions:

  • Do I want exposure to the real estate industry?
  • Do I understand the risk of investing, and the risks associated with real estate investing?
  • How much money am I willing to invest in real estate?
  • Are REITs my best choice or do I want to own physical property?
  • If I am going to buy REITs, do I want to buy a fund or individual REITs?
  • Do REITs, and real estate in general, align with my investment and retirement goals?

These are the types of question you should ask yourself before any investment, and the same goes for REIT investing.

We’ve learned that REITs offer portfolio diversification, excellent dividend yield, cash flow potential, and long-term appreciation opportunity.

It’s now up to you to decide if they are right for your future.

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Quick Summary

Account Minimum Investment: $500

Fees: 1%/year

Promotion: No current promos


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