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Real estate investment trusts, REITs for short, allow individuals to invest in portfolios of real estate assets in the same way they can invest in portfolios of other securities through mutual funds and similar securities.
If you're thinking about investing in real estate through REITs, here's a step-by-step guide to help you get started.
1. Understand How REITs Work
REITs are companies that invest in income-producing real estate assets. REITs are modeled after mutual funds: Instead of investing in just one or two properties as you might as an individual investor, they invest in a portfolio of properties. This setup gives investors the chance to take advantage of real estate investing without needing to buy their own properties.
There are many different types of REITs that invest in different types of properties, which can include but aren't limited to:
- Retail centers
- Office buildings
- Self-storage buildings
- Apartment complexes
Similar to stocks, REITs can be listed on a major stock exchange, making it easy for investors to buy shares. The companies are required to distribute 90% of their taxable income annually as dividends to shareholders, making them a decent option for income investors.
2. Know the Risks of REITs
While REITs are a popular way for investors to get into real estate without owning their own properties, there are some potential risks involved—particularly with REITs that don't trade on a major stock exchange.
Non-traded REITs can charge high upfront fees to get in, and it can be more difficult to buy or sell shares because the market is smaller compared with REITs trading on a major exchange. Finally, with REITs that aren't publicly traded, it can be more difficult to do research on past performance to get an idea of whether it's a good investment.
With REITs that do trade on a major exchange, dividends are taxed as normal income rather than as long-term capital gains, which can impact your tax bill at the end of the year. Additionally, if you're not familiar with the real estate market, it can be difficult to know if you're getting in on the right type of investment property. Finally, REITs haven't performed well historically during times when interest rates are on the rise, primarily because investors flock to safer income investments like U.S. Treasury bonds. So you'll need to keep an eye on the interest rate environment as you make your trades.
3. Consider How Much You Can Afford to Invest
As with any investment, it's important to know how much you can afford to set aside and put at risk. While real estate experiences different fluctuations from the stock market, there's still a risk of losing money on your investment.
Also, if you're planning to invest in a REIT that isn't publicly traded, you'll need to think about how much money you can reasonably lock up for a long period of time since you can't be sure how liquid your shares will be in the event that you want to sell.
Finally, while REITs can help diversify your asset allocation, you'll still want to make sure you're investing in other asset classes, such as stocks and bonds, to make sure you're not putting all of your eggs in one basket.
4. Choose a REIT to Invest In
As with any investment, it's crucial that you do your due diligence before you decide which REIT to invest in. For starters, you'll want to take a look at the track record of the REIT managers. Review the past performance of the REIT and compare it to others to get an idea of which ones have performed better than others.
You'll especially want to pay attention to earnings, which include the funds the company earns from its operations and the cash available for dividends.
Also look at how REIT managers are compensated and other fees that are associated with the investment.
Next, take a look at how the REIT is diversified. There's nothing wrong with REITs that invest heavily in one type of property. But if market conditions impact a certain type of property more than others, you could end up with higher losses. As a result, it's good to consider REITs that diversify broadly or to invest in multiple REITs to diversify within your own portfolio.
5. Open a Brokerage Account
Once you know which REITs you want to invest in, you'll need to open a brokerage account to be able to make trades. If you already have a brokerage account, you'll likely be able to use that one. But if not, take your time to compare multiple options to find the right fit for you. There are many different brokers available, with the top ones offering no-commission trades, so you don't have to worry about extra fees.
In addition to costs, also look at the different investment options each broker offers and the level of educational resources and tools that are available for you to use. Once you've found the right one, open an account and make your initial deposit. As soon as the cash is available to trade, you can get started.
Who Should Invest in REITs?
REITs are very common, so just about any investor may find them worth investing in. For example, if you have a pension or a 401(k) plan with target-date funds, you may already have REITs in your portfolio.
People who may consider investing in REITs on their own, however, may be interested because they offer the chance to diversify their portfolios beyond stocks and bonds. And like bonds and high-yield dividend stocks, REITs can provide a steady source of income through dividends.
Finally, you may want to invest in REITs if your goal is to invest in real estate but you don't have the cash reserves to buy investment properties, or you want something more liquid. Selling a home can take months, while selling a REIT takes just a few mouse clicks.
Consult With a Financial Professional
If you're not sure about whether or not to invest in REITs, consider consulting with a financial advisor who can help you develop a strategy for your investment portfolio. An advisor can give you personalized advice based on their experience managing investments and may even be able to manage your portfolio on your behalf.
Even if your end goal isn't to have someone else manage your money, though, working with an advisor can help to determine how you want to approach investing for your future.