From afar, owning real estate as an investment seems like a golden goose. If you play your cards correctly, you can earn unearned income for years to come. However, few people have the time or money to buy and manage their own property. That’s where real estate investment trusts (REITs) come in.
“REITs are a very low-cost, effective and liquid way to invest in commercial real estate and are, in fact, widely available to the public,” says the National Association of Real Estate Investment Trusts (Nareit), an advocacy group.
What are REITs?
A REIT is a company that owns, operates, or finances income-generating properties such as retail centers, shopping malls, hotels, healthcare facilities, multifamily homes, and office buildings.is more than 500,000 properties In the US, it is owned by a REIT, according to Nareit.
Buying stock in a REIT is just like buying stock in any other company, except the REIT only generates income from real estate.
While commercial real estate has historically been in the hands of wealthy and institutional investors, McCarthy said, REITs offer a slice of the pie to everyday investors. “Because REITs are total return investments, they typically offer high dividends and moderate capital appreciation potential over the long term,” she says.
Structure of REITs
A REIT collects rent, operating expenses, or interest payments from the properties in its portfolio. It then turns around and provides the majority of its income to shareholders in the form of: dividend. according to Narite dataREITs listed on major stock exchanges, paid out more than $51 billion in dividends to investors in 2020.
REIT properties typically share an overarching theme. For example, a healthcare REIT may own or finance hospital, nursing home, or medical office buildings. Residential REITs have apartments and student dormitories. Self-storage REITs own and manage storage facilities. Diversified REITs contain different types of properties.
The IRS requires companies to meet the following requirements to qualify as REITs:
At least 90% of annual taxable income must be distributed to shareholders.
Must be governed by a board or board
Corporate registration required
Requires at least 100 shareholders
At least 95% of your gross income must come from real estate and at least 75% must come from a specific source of income.
At least 75% of total asset value must be invested in real estate assets, cash or cash-like instruments, and government bonds.
3 types of REITs
REITs can be broadly divided into three categories. The main difference is whether you own/manage the property or finance it. Some do both.
Equity REITs: This type of REIT typically owns several properties concentrated in one sector, McCarthy said. Tenants pay rent to her REIT, which turns around and pays dividends to shareholders.
Mortgage REITs: REITs that finance rather than own real estate are called mortgage REITs or mREITs. Income is derived from interest on principal mortgages or mortgage-backed securities and paid out to investors as dividends.
Hybrid REITs: These REITs own real estate, fund it, and use both strategies to generate income.
REITs are also classified according to how they are available to investors. That is, either inside or outside the major stock exchanges. Details of the three types of transaction statuses are as follows:
Listed REITs: Equity REITs are listed. That means they are listed on major stock exchanges such as the New York Stock Exchange (NYSE). Regulated by the Securities and Exchange Commission (SEC), they tend to be more transparent than non-listed REITs. REITs can be listed directly on exchanges (according to Nareit, there are 209 listed REITs as of October 2022). Alternatively, it can be part of a mutual fund or exchange traded fund (ETF) comprised of multiple REITs. Like publicly traded securities, REITs come with risks, says McCarthy. A variety of factors such as the current political climate, interest rate environment, geography, and tax laws can affect the performance of an equity he REIT.
Public, non-trading REITs: Unlisted REITs are not traded on domestic stock exchanges but are still regulated by the SEC. They tend to have higher minimum investment amounts and longer holding periods, making them harder to sell (less liquid) and more risky than listed REITs.
Private REITs: This unregulated REIT is reserved for wealthy investors and financial firms that manage pension plans. Returns can be high, but performance is often difficult to track.
REITs that produce high dividends are especially attractive to investors when prices for commodities and services, such as rent, are rising. “There’s inflation protection that some assets don’t have,” says Associate Wealth Advisor and Investment Analyst Michael Becker Hightower Wealth Advisors in St. Louis. But he adds that the impact of COVID-19 has rocked commercial real estate. Shoppers rely heavily on e-commerce, and many businesses aren’t back in the office.
“Not all real estate trends of the last decade are predictable for the next decade,” he says, reminding investors to choose carefully which REITs they invest in.
How to invest in REITs
Nareit’s online database View current stock prices, annual returns and dividend yields for over 180 publicly traded REITs. You can purchase stock using a taxable brokerage account or tax-advantaged retirement account, such as a workplace 401(k) or IRA.
“Because REITs are publicly traded securities, investors can access them by directly picking stocks,” McCarthy says. “However, the majority of investors actually invest in his REITs through actively managed mutual funds. index fundor ETF products.
A fund is a basket of multiple companies. We research, screen and select REITs that meet specific goals and values. By owning shares in multiple companies, McCarthy says investors can increase returns without taking on risk.
If you’re interested in non-trading REITs, check out platforms like Fundrise and DiversyFund.if you qualify as accredited investorconsider a platform like Yieldstreet, or talk directly to a financial advisor.
But remember: Investments bought and sold through a retirement account are generally not accessible without penalty until retirement age. If you’re looking for a current source of income from dividends, a brokerage account may be a better fit, although there are tax rules to consider.
How REITs are taxed
REITs must be registered as legal entities, but typically do not pay corporate tax. Instead, business income flows as dividends to shareholders who are responsible for paying income taxes.
Generally, dividends paid out through REITs are considered “non-qualifying” for tax purposes. This means that the investor’s normal income tax rate will apply, rather than the lower capital gains tax rate that applies to long-term stock gains.
“For high-income earners, [rate] It can be close to 40% in some conditions,” says Becker. “For low-income people, it can be mid-to-late teens.”
Some dividends are a mix of ordinary income and capital gains. This happens, for example, when a REIT sells a property he has owned for over a year and donates a portion of the proceeds to shareholders.
Ultimately, the account you use to invest in the REIT will determine the tax treatment of your dividends. A tax deferred account like an IRA avoids paying taxes on annual dividends because you haven’t pocketed the money yet. Dividends are reinvested, combined with other invested capital and earnings, and taxed as ordinary income when withdrawn at retirement. In a brokerage account, REIT dividends are taxed annually.
Real estate investments tend not to track the performance of stocks and bonds, making them an excellent tool for diversification. For investors in need of liquidity, REITs can be a sensible alternative to owning physical real estate.
REITs offer investors a way to profit from the more stable side of the real estate market, but their trajectories are largely unpredictable. People pay rent for as long as they need a place to do business: retail stores, offices, medical facilities. Also, as long as the REIT collects rent payments, it must share at least 90% of its income with investors.
This story was originally Fortune.com
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