Alternative and Emerging Products

Real Estate Investment Trusts: Alternatives to Ownership
Real Estate Investment Trusts: Alternatives to Ownership

Investing in real estate can be a good way to diversify your assets. But if you don’t want the responsibilities that come with ownership, real estate investment trusts (REITs) can provide exposure to real estate without requiring you to actually buy or sell property.

Established by Congress in 1960 as a way for individual investors to invest in large-scale, income-producing real estate, REITs are companies that own or finance income-producing real estate or related assets. Today there are REITs that own everything from office or apartment buildings to hotels to mortgages or loans, with many specializing in a single type of real estate, such as retail, residential or industrial, among others.

Some REIT products are more complex than others. Research the different types of REIT investments and make decisions based on your overall investment goals.

Understanding the Basics

There are three main types of REITs:

  • Equity REITs typically own and operate income-producing real estate.
  • Mortgage REITs (mREITs) provide financing to real estate owners and operators, either directly in the form of mortgages or other types of real estate loans, or indirectly through investments in mortgage-backed securities.
  • Hybrid REITs use investment strategies of both equity REITs and mortgage REITs.

REITs are classified as follows:

  • Publicly traded REITs are bought and sold by investors on national securities exchanges, just like individual shares of public company stock, and are regulated by the Securities and Exchange Commission (SEC). As with other publicly traded securities, investors can purchase REIT common stock, preferred stock or debt securities.
  • Public non-traded REITs are also regulated by the SEC but are not traded on a national exchange. These REITs typically fall into one of two buckets:
    • Net asset value (NAV) REITs, which have become more common, regularly calculate the value of the holdings in their portfolios and offer to sell or redeem shares in the REIT based on the latest NAV per share.
    • Other fixed-priced REITs offer shares at a set price. These public non-traded REITs typically appraise their assets far less frequently than NAV REITs (perhaps only once per year) and tend to be less liquid.
  • Private REITs are neither regulated by the SEC nor traded on national exchanges and are primarily sold to institutional or accredited investors.

Investing in REITs

There are a number of reasons investors might gravitate to REITs. In addition to offering diversification, REITs hold the potential to provide a stream of dividend income, since REITs must distribute 90 percent of their taxable income to shareholders annually in the form of dividends.

Publicly traded REIT shares might also increase—or decrease—in value, just as any stock, though dividend income tends to drive REIT investing rather than appreciation of capital. You buy and sell publicly traded REITS as you would any stock.

All REITs come with fees and expenses, as well as risks, including the risk that your investment could lose some or all of its value. Other REIT risks vary depending on the type of REIT you own. For example, publicly traded REITs tend to be more liquid but also more prone to price swings (volatility) than non-public REITs. Changes to interest rates, property values and the economy may also affect the returns of REIT investments.

As with any investment, it pays to do your research since each REIT is different. Before investing, research the registration status and review recent filings of publicly traded and public non-traded issuers using the SEC’s EDGAR database, and consult a tax professional to understand the tax implications of different REIT products.

For investors seeking exposure to real estate, another option is to invest through REIT mutual funds or exchange-traded funds (ETFs). These products generally offer a basket of REITs that provide broader exposure to real estate investments than can be obtained from a single REIT.

A final word of caution: REIT fraud is real. Sales tactics might include using false information, overpromising returns and underplaying risks, and promoting REIT-like products that are, in fact, not REITs and have less liquidity and additional areas of risk. Carefully read all supporting material, and consider seeking input from an investment professional before making this type of investment.