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Investing in commercial real estate is one of the best ways to diversify your portfolio and protect yourself in a volatile market landscape.
Unfortunately, because of either time or financial constraints, real estate investing is unfeasible for many investors.
Commercial real estate investment trusts (REITs) offer non-accredited, everyday investors the opportunity to add commercial real estate to their portfolios without getting directly involved in purchasing property themselves.
What Are Commercial REITs?
Commercial REITs are companies that invest in income-producing properties. They collect money from many individual investors and pay out dividends from their profits.
There are many kinds of REITs. Some exclusively invest in residential real estate, while others invest in alternative types of property.
Commercial REITs invest in commercial real estate. Some specialize in certain categories, while others have broad, diversified portfolios.
Commercial properties can include, but are not limited to
- Land (forests, farmland, etc.)
- Office buildings
- Industrial units
- Retail space
- Hospitality businesses
- Healthcare centers
How Commercial REITs Work
In 1960, Congress created a system by which ordinary Americans could invest in real estate without directly purchasing or managing the real estate themselves.
REITs quickly gained popularity as dividend-paying, high-quality investments.
REITs follow strict guidelines that the Securities and Exchange Commission (SEC) determines. These regulations dictate many aspects of the REIT, including the number of investors, the distribution of shares and the paying of dividends.
Commercial REITs, which are a kind of REIT that invests primarily in commercial real estate, must follow the same regulations as other REITs.
Commercial REITs collect money from individual investors and use that money to purchase real estate. These companies make a profit from their investments in several ways:
- Managing leases: Many REITs lease their properties out to tenants. Whether this is retail or warehouse space, after maintenance costs and paying investors, all income from these leases constitutes profit.
- Increasing property value: Another important way REITs can generate money is by “flipping” properties — i.e., they buy in a growing market, and once the property has appreciated in value, the REIT sells it on quickly to make a profit.
- New property development: Some REITs invest in land development with a view to renting out these future properties or selling the developed land for a profit.
- Selling goods: Some commercial REITs own land that makes money in other ways, such as forests that produce lumber or agricultural land for farming.
How commercial REITs work for investors
After deciding which REIT you would like to invest in, the process of growing your wealth through a REIT is easy.
REITs work like regular dividend stocks. The SEC requires REITs to set aside a specified minimum percentage of their profits to pay dividends to their investors.
Dividends can range anywhere from a few cents to a few dollars per share. Aside from dividends, if you opt to invest in traded REITs, you can also make money by selling your shares when you want to liquidate.
Example of a Commercial REIT
To better understand commercial REITs, you can look at individual investment trusts.
For example, the Prologis REIT (NYSE: PLD) is a commercial REIT focusing on logistics and transport. It is one of the largest of its kind in the world, and it generates income by renting out warehouse space.
Prologis has multiple avenues for increasing profits if it so desires, all of which require investors for capital, including
- New property: Prologis can purchase additional warehouses to rent out for profit.
- Value-add investments: The company may also channel its funds into improving its existing warehouses, such as by adding refrigerated space that can be leased for higher rates or by enhancing the services it offers to its customers.
In either case, Prologis will need more capital to implement these activities. The REIT gets this capital from investors, whom it attracts with the promise of high dividends and financial growth.
Commercial REITs vs. Residential REITs
Commercial REITs and residential REITs work similarly, but there are key differences that you should understand before choosing to invest in either one.
Commercial REITs invest in commercial property. However, this is a broad statement, and there are many types of property that commercial REITs may specialize in, including multi-family residential property.
Both residential and commercial REITs depend on interest rates, though residential REITs are more likely to succeed when interest is high.
Additionally, economic downturns are more likely to affect commercial REITs, as most commercial goods are considered non-essential.
Residential REITs and commercial REITs can hedge against inflation because they are both based on commodities, which generally keep pace with inflation.
Benefits of Commercial REITs
Passive income: Investing in a REIT is much easier than investing directly in property yourself because the REIT does all the hard work for you.
High-paying dividends: Dividends provide investors with cash flow. If you invest in a commercial REIT, you can enjoy high dividends without withdrawing your initial investment.
Low minimum investment: As an investor, you do not need to put up exorbitant amounts of cash to make a profit.
Diversification: REIT investing allows you to easily add multiple types of real estate properties to your portfolio without purchasing and managing your own properties or needing to possess specialist knowledge of the different asset classes.
Professionally managed: If you were to buy an investment property to own and manage yourself, you would likely have less success than a typical REIT.
REITs employ industry experts who can devote full attention to managing their properties.
Risks of Commercial REITs
Taxed on dividends: Some investment types have tax benefits and will not require you to pay taxes. These tax benefits do not exist for REIT investments.
All dividends from REITs are taxable income. Depending on how you declare them on your return, you will have to pay either capital gains tax or income tax on REIT dividends.
Less control: REITs professionally manage investment portfolios. As a typical investor, you will have no say in which markets the REIT wishes to enter.
Illiquidity: Shares in traded REITs can be bought and sold on the stock market like any other stock option, but shares in non-traded REITs have very little liquidity.
In most cases, you will not be able to back out of your investment for at least several years.
High-interest rate risk: REITs are, by their nature, dependent on real estate. When real estate interest rates rise over an extended period, REITs can be at risk of sustaining significant losses.
Low demand: Unlike residential REITs, demand for shares in commercial REITs is highly dependent on the economy.
In the case of a downturn, demand for commercial real estate can plummet.
3 Best Commercial REITs to Invest in 2023
There are many REITs operating in dozens of niches. Knowing which to choose for your first investment can be overwhelming.
Overall, these three commercial REITs are likely to do well in the coming year, making them excellent choices if you are just getting into real estate investing.
Ares Real Estate Income Trust (AREIT)
Ares manages a vast, diversified investment portfolio. It became an independent investment firm in 2002 and now manages more than $50 billion in assets worldwide.
The company has achieved this growth by targeting fast-growing, liquid markets with high earning potential.
- Best: Long-term investment
- Markets: International
- Types of Investments: Office buildings
Orion Office REIT (ONL)
Orion Office REIT (NYSE: ONL) is a high-dividend REIT with investments across the US. The company is run by some of the most experienced industry experts in the country.
Since the pandemic caused the recent office crash, now is one of the best times to invest in office space.
- Annual Dividend Yield: 4.27%
- Best: High-dividend investment
- Markets: Properties in all regions of the U.S.
- Types of Investments: Office space
Public Storage REIT (PSA)
Public Storage (NYSE: PSA) is a commercial REIT that invests in the self-storage industry.
Since its founding in 1972, the company has opened facilities in more than 40 states and has become the world’s largest operator of self-storage units.
- Annual Dividend Yield: 2.71%
- Best: Commercial industrial REIT
- Markets: Facilities across the U.S.
- Types of Investments: Self-storage
How to Invest in Commercial REITs
Investing in commercial REIT stocks is like investing in any other dividend-paying stock. Here is how you can get your investment started:
- Find a brokerage: To invest in a traded stock, you will need to go through a brokerage. Many brokerage companies offer different benefits, such as fractional shares or bonus stocks for signing up, so looking for one that will work best for you is essential.
- Set a budget: Before considering your options, you should select a budget and adhere to it, even if it means you can’t buy the stock you would like. Never invest more than you can afford to lose — returns are never guaranteed.
- Find a stock: There are many commercial REITs offering different dividends, options, and stock prices. Research and talk to a financial advisor if you aren’t sure which is right for you.
- Purchase stock: Once you have decided which stock you wish to invest in, follow the steps laid out by your brokerage to make a purchase.
- Take dividends and watch your asset grow: Most dividends are distributed automatically. Now you can simply sit back and watch your investment grow then choose whether to reinvest your dividends or take them as income.
Is a Commercial REIT a Good Investment?
With recent market volatility, it makes sense for you to add a diversified stock option to your portfolio. Investing in a commercial REIT is the ideal way for you to achieve this.
Commercial REITs are often good investments and have outperformed most other options in the past few years, a trend that shows no signs of stopping.
Commercial REIT FAQs
Below are the most frequently asked questions about commercial REITs.
How do I assess the value of a commercial REIT?
The best way to assess the value of any given commercial REIT is to look at its funds from operations or adjusted funds from operations.
What is the difference between a commercial and a mortgage REIT?
Commercial REITs own and manage properties for profit, while mortgage REITs offer loans to other management companies and individuals.
What is the best commercial REIT ETF?
Many people consider the Vanguard Real Estate ETF (NYSE: VNQ) to be the most robust commercial exchange-traded fund on the market.