Investing in the Real Estate Investment Trust: Top 5 Benefits & 5 Demerits

By Chika


Last Updated: October 26, 2021


Real estate is getting more expensive. The once safe haven for preserving wealth is slowly slipping beyond the reach of the average person or couple.

Home prices are soaring, while rents are rising at an alarming rate. Perhaps more worrisome is that institutional investors with deep pockets are now playing a more prominent role in the real estate market.


Single Family Homes Are Being Snapped Up By Investors

According to the Wall Street Journal, yield-chasing investors are snapping up single-family homes, competing with ordinary Americans, and driving up prices. The world's largest fund, BlackRock is reportedly said to be acquiring single-family homes, paying 20-50% above market value.

These financial bigwigs are raising rents at the fastest rate since they emerged from the last decade’s foreclosure crisis. Data collated by real-estate analytics firm Green Street showed that asking rents for available properties spiked by 7.5% in October.

This is the fifth straight monthly increase and the biggest since the firm began tracking in 2014 when financiers were still gobbling up foreclosures.

The Federal Reserve is set to raise interest rates to tackle inflation. Coupled with the insatiable appetite of America's mega landlords, prospective homeowners should expect to dole out more money from their pockets.

Owning a home may soon be a luxury for most Americans. For those unable to chalk out the down payment for a mortgage, REITs provide a cost-effective way of owning a home and getting a steady source of income. 

This article provides an insight into REITs and how investors can make money from real estate without owning a property.


What are REITs?

REIT is an acronym that stands for Real Estate Investment Trust.

These are companies that own or finance commercial real estate for the purpose of generating income. REITs are modeled like mutual funds, which imply that funds are pooled from multiple investors to finance the purchase and management of the property. Dividends are shared among the fund holders.

Real estate investment trusts are a viable way of participating in commercial real estate as an investor without owning the properties yourself.

They are a good way for investors to diversify their real estate portfolios with much less risk than if they were landlords. Like stocks, REITs are traded publicly on the stock exchange, which makes them easily accessible to investors.


5 Benefits of Investing in REITs

There are several advantages that come with investing in REITs, let's have a look at some of them. 

1. Steady dividends

REITs are required to pay 90% of their yearly income as dividends to shareholders. REITs offer some of the largest dividend pay-outs in the stock market and have an enviable track record of consistent payment. This has made them a viable investment for investors looking for a steady source of income. 

2. High returns

REITs potentially have a higher return than most stocks and even the broader index. This is due to their consistent dividend payments which can be reinvested to grow the portfolio. 

3. Easier to invest than physical properties

Investing in REITs is less laborious than buying a physical property, managing it, and reselling it. REITs are traded like shares which means they can be bought and sold at any time, simplifying the investment process. 

4. Lower volatility

REITs tend to have a lower trading volume than individual stocks which makes them less volatile. With many market players focused on high growth, mega-cap stocks, REITs usually fly below the radar of most investors and traders.

This low volatility can help in portfolio balancing by reducing the drag on your portfolio by more volatile stocks.

5. Portfolio diversification

REITs are also a good source of portfolio diversification.

They can perform well during periods of inflation and rising interest rates. These can weigh heavily on the broader equity market because investors would be rotating into safer assets such as bonds.

Having REITs in your portfolio can hedge against potential losses during such times, while providing dividends that can be reinvested to further reduce losses. 


5 Demerits of Investing in REITs

Several disadvantages come with investing in REITs. Let's have a look at some of them.

1. Illiquidity

Apart from publicly traded REITs, it can be challenging selling shares of REITs. Getting buyers for non-traded and private REITs can be difficult. Some have to be held for years before an investor realizes gains.

2. Heavy debt

Due to the lure of constant expansion to increase revenue and appease shareholders, most REITs are heavily indebted.

REITs are among the most indebted companies in the market, which could be a worrisome sign especially if the housing market crashes as experienced in 2008. However, long-term contracts such as leases can generate steady cash flow which can be used to finance debt payments. 

3. Low growth and capital appreciation

Since REITs are required to pay as much as 90% of their income as dividends to shareholders, this can affect their growth and capital appreciation. To raise cash, some REITs may have to issue new shares, which may be interpreted by the investment community as a sign of financial struggles. 

4. Tax burden

Dividends from REITs are taxed, which potentially reduces the profits made on investing in their stocks. One way investors can side-step this is by investing in REITs through their IRAs. 

5. Expensive and restrictive

Investing in non-traded REITs can be expensive and beyond the reach of the retail investor that has little cash to invest in. The initial investment in some non-traded REITs can go upwards of $25,000. Secondly, buying shares in such REITs is limited to institutional investors or high net-worth individual investors. 

Read this next: Inflation: Should You Stick With Growth Stocks?


How to Invest in REITs

Individuals can invest in REITs in a plethora of ways. You can invest in publicly traded REITs or their private (non-traded) peers.

There are also a variety of options when it comes to investing in publicly traded REITs.

Investors can choose from:

  • Equity REITs
  • Mortgage REITs
  • REIT mutual funds

Better still, investors can narrow down their search to a particular type of REIT. You can invest in:

  • Data center REITs
  • Residential REITs
  • Hospitality REITs
  • Healthcare REITs, etc.

The key is finding one that suits your investment purpose or choosing a sector that you have some knowledge about. 


Key Takeaway

Investing in REITs is a low cost way of getting income from real estate investments.

There are different ways one can gain exposure to the real estate market without owning physical property.

REITs are a good long term investment strategy.

Their low volatility also makes them a good addition to your portfolio. They can taper the price movement of more volatile holdings.

The dividends if reinvested can reap bountiful gains in the future. Why wait until you buy a property?

Why not invest in REITs to take advantage of opportunities in the real estate market?

Photo by RODNAE Productions from Pexels


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