REITs: Everyone has heard of them, half know what the acronym stands for, but far fewer understand what they actually do. While an exhaustive discussion on REITs could fill many pages, I aim to concisely outline their functions, their role in the investment landscape, and their worthiness for further exploration.
REITs operate similarly to large corporations like Boeing, Apple, or McDonald’s. However, instead of producing planes, iPhones, and Big Macs, REITs exist to own cash-flowing real estate. Ownership in a REIT is divided into shares, which can be traded privately or on the open market if the REIT is publicly traded.
REIT Pros
A key difference between REITs and regular corporations lies in their tax advantages. REITs can avoid paying income taxes if they distribute 90% of their earnings (mainly rental income) to shareholders as dividends. To enjoy this status, REITs must adhere to strict guidelines.
Typically, REITs own large Class A multifamily, office, industrial, and various types of commercial buildings nationwide. This allows investors to hold a diversified portfolio of high-quality assets without the need to directly purchase such properties. Moreover, shares in publicly traded REITs offer far greater liquidity compared to other real estate investments, where funds may be tied up for years. With a publicly traded REIT, you could buy shares one day and sell them the next.
However, these advantages also come with downsides.
REIT Cons
One major drawback is relatively low returns compared to direct investment in real estate projects or funds. While REIT dividends may appear generous next to typical dividend-paying stocks, the returns can seem minimal. This is because REITs invest in high-quality, low-risk assets and are managed by highly compensated professionals.
Another risk is systemic; owning large, Class A properties across various cities might seem like sound diversification, but what happens during a pandemic when the necessity of office spaces is reevaluated?
Other risks REITs carry is their exposure to short term stock market trends. Since many REITs are public companies their shares are generally traded on indexes such as the NYSE or Dow. Just like with any stock, general market conditions can have a positive or negative affect on the market capitalization of the REIT. In short, this means the share price can swing up or down, without and fundamental business changes occurring in the REIT.
In Summary
REITs serve as a bridge between the financial and real estate worlds, offering a viable option for those seeking to invest in secure, relatively liquid assets within an industry notorious for its illiquidity.
