New or seasoned investors normally have a hard time choosing what they want to invest in. After all, there are many things you’ll have to think about before investing, like researching the market, taking into account the measure of the risk of the investment, thinking of a solid financial strategy, and many more.
But, many people agree that one of the best investments is in real estate. This is because of the relatively low measure of risk. In fact, according to a joint study by a German Central Bank and several U.S. universities, getting into real estate investment has higher returns and much lower risk than investing in stocks. Plus, 90% of all the millionaires in the world made their money via real estate.
Knowing where to put your money is as important as knowing how you are going to earn from it as well.
What Is a REIT?
A Real Estate Investment Trust is a corporation that either owns, manages, or finances income-producing real estate assets. There are more than 225 of them registered to the SEC, and they all have a combined equity market value of 1 trillion dollars.
A REIT’s structure is just like a mutual fund, where an investor gathers his/her funds to buy a share of the commercial real estate.
Then, the trust will gather all the investment capital from the investors to fund their real estate assets. Then, after a set period of time, they’ll distribute that income to the shareholders depending on how much they invested, also known as a return in investment. The average return from a REIT is usually 10% of what was invested by the investor.
Benefits of REITS:
Just like every investment method, investing in a REIT has its strengths and risks.
One of the biggest reasons many real estate investors invest in a REIT is that investment pays back with really high-yield dividends. That means they are required to pay 90% of the taxable income to their investors, meaning the shareholder dividends paid back are higher than the common stock on the S&P 500 index. This is one of the advantages of a REIT, a steady dividend income that doesn’t stop.
Another great thing about them is that they provide investors with a diversified portfolio. There are many different kinds of them you can invest in, like Residential REITS, which deal with rental properties and manufactured housing, and Mortgage Trusts, which are involved in mortgage investments. But, more on that later.
Also, they give people the ability to go out and purchase commercial properties for a passive income. Many people want to invest, but they want to do so without dealing with the many troubles real estate properties can have such as talking to brokers, adding value to a property, dealing with tenants’ issues, and etc. REITs give you the chance to invest in properties, without having to deal with the nightmares mentioned previously. Plus, they have high liquidity, meaning they can be bought and sold instantly, unlike Direct Real Estate Investing, with suffers from a lack of liquidity.
However, with the above-average income also comes an unchanged tax. That means that the dividend yield, although high, has no tax advantages. This means it is taxed as ordinary income, which results in no tax deduction in the income to shareholders.
Another risk would be that they are sensitive to interest rates. That means that when interest rates rise, the worth of a REIT falls, meaning there’ll be much less money coming in. On top of that, each type of property has its own specific risk that you’ll need to research.
The last con is the relatively low appreciation. Because of how they work 90% of the income is given to investors, which means they only have 10% to invest into their real estate assets or to expand their real estate portfolios.
Don’t Get Scammed!
However, there’s been a practice that has been going on for quite some time called: REIT Fraud. This means that the trust invested in won’t be beneficial because it’ll scam the investors.
There are many ways to perform this type of fraud. Some investment trusts will promise too good to be true annual returns, and then not deliver on those promises. Others will cut off their monthly/annual distributions, meaning they won’t give the profits to shareholders, so they’ll be at a loss.
One example of a trust that did this is called the Northstar Healthcare Income REIT. This Real Estate Investment Trust lost 30% of its value in 2018. Because of that, it decided to stop giving distributions of income, meaning its investors earned nothing in return.
The best way to avoid these types of fraud would be to do these two things. First, research the REITs you’re planning to invest in. This could help you from falling into this type of fraud, as researching will give you a perspective on how much the share’s return potential, worth, and value is. Another thing you can do would be to avoid getting into REITs not registered in the SEC, also known as the Securities and Exchange Commission.
Types of REITs:
Now that you know what a REIT is, you must now understand its many different types. Each one specializes in its types of property and has its strengths and weaknesses, so take those into account before considering which one you’d like to fund.
Retail REITs: These investment trusts specialize in retail centers, meaning buildings like large malls, outlet centers, shopping centers, and the like. This is actually the biggest investment type among the REITs, as 24% of all REIT investments are solely towards this category.
Remember, the sales from this type of trust are dependent on the rent they charge their tenants, namely all the shop owners renting space. This means that if the retailers experience problems like low cash flow, the mall will undoubtedly be affected also, which could potentially turn into a big problem. When choosing which to fund, fund the ones with the strongest tenants possible, meaning those with a continuous income.
Residential REITs: They are exactly what they sound like, being involved in multi-family apartment buildings and manufactured housing. They specialize in rental properties and manufactured housing, like multifamily apartment complexes and residential properties, like small to large houses.
Just like retail properties, these are heavily dependent on the rent their tenants pay them. This means that if the tenants have rent problems, the investment trust won’t earn money, meaning you won’t get a large return on investment. To prevent this, look for rental/single-family properties with the strongest tenants, those that don’t have problems with paying their rent. Also, look for REITs with well-maintained properties, as they have a large potential to be a cash cow for years to come.
Mortgage REITs: They invest in mortgages, unlike most others that invest in equity. They provide financing to build properties, and in return get their fundings back with interest. This type of REIT is very versatile, as it provides funding to many different types of properties.
But while this type is versatile, it comes with a few disadvantages. First, it is heavily linked to interest rates, meaning if interest rates rise, there will be a decrease in the value, driving the stock price lower. Also, mortgage REITs get their funds from debt offerings, so if interest rates rise, the worth of the mortgage loans will be much lower.
Hybrid REIT: A Hybrid REIT is a special type because it owns properties and provides mortgages. Being an all-rounder, it has all of the advantages and disadvantages of equity and mortgage REITs. This means it is a relatively low risk.
How to Choose:
Now that you know what the many types are, you’ll now need to choose a REIT for you to invest in. However, you have to make a lot of research before jumping head-on. Some things you’ll need to consider are:
- The Risks And Advantages:
First, remember to take into account the risks and advantages of all the REIT types. You may want something that is a high risk, and high reward, or maybe you’ll want one with low risk, and earn a slow but sure passive income.
Doing this can help you make your financial strategy.
- Management:
When funding a trust, make sure to look at what team is managing the trust’s real estate assets. Take a look at the team’s track record and how they manage their properties. This would give you an idea as to whether you want to entertain them or not.
- Funds:
Finally, look at the REIT’s funds for its assets, and the cash available for distribution. Measuring these numbers can give you an idea of how well the REIT works, effectively telling you how much you’re going to get, and when.
Overall, investing in a REIT has the potential to be rewarding. Once you take all of this into consideration, you’ll be able to find the REIT best for you. Who knows, this could be your first step to your own million-dollar fortune!
