A Few Tips for Getting Started with Real Estate Investment Trusts (REITs)
Since its inception, REITs have provided pathways for investors to diversify their investment portfolios through many types of commercial income-producing real estate.
If you’ve ever considered investing in a REIT, here are a few things that you should know before getting started.
What are REITs?
Real estate investment trusts (“REITs”) allow individuals to invest in large-scale, income-producing real estate.
A REIT is a company that owns and typically operates income-producing real estate or related assets. These may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, mortgages, or loans.
Unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties to operate them as part of its investment portfolio.
Why would somebody invest in REITs?
REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy commercial real estate.
What types of REITs are there?
Many REITs are registered with the SEC and are publicly traded on a stock exchange. These are known as publicly-traded REITs.
Others may be registered with the SEC but are not publicly traded. These are known as non-traded REITs (also known as non-exchange traded REITs).
This is one of the most important distinctions among the various kinds of REITs.
Before investing in a REIT, you should understand whether or not it is publicly traded and how this could affect the benefits and risks to you.
What are the benefits and risks of REITs?
REITs offer a way to include real estate in one’s investment portfolio. Additionally, some REITs may offer higher dividend yields than some other investments.
But there are some risks, especially with non-exchange traded REITs.
Because they do not trade on a stock exchange, non-traded REITs involve unique risks:
- Lack of Liquidity: Non-traded REITs are illiquid investments. They generally cannot be sold readily on the open market. If you need to sell an asset to raise money quickly, you may not be able to do so with shares of a non-traded REIT.
- Share Value Transparency: While a publicly traded REIT market price is readily accessible, it can be challenging to determine the value of a share of a non-traded REIT.
Non-traded REITs typically do not provide an estimate of their value per share until 18 months after their offering closes. This may be years after you have made your investment.
As a result, for a significant period, you may be unable to assess the value of your non-traded REIT investment and its volatility.
- Distributions May Be Paid from Offering Proceeds and Borrowings: Investors may be attracted to non-traded REITs by their relatively high dividend yields compared to those of publicly-traded REITs.
Unlike publicly-traded REITs, however, non-traded REITs frequently pay distributions in excess of their funds from operations.
To do so, they may use offering proceeds and borrowings. This practice, typically not used by publicly traded REITs, reduces the value of the shares and the cash available to the company to purchase additional assets.
- Conflicts of Interest: Non-traded REITs typically have an external manager instead of their employees.
This can lead to potential conflicts of interest with shareholders.
For example, the REIT may pay the external manager significant fees based on the number of property acquisitions and assets under management.
These fee incentives may not necessarily align with the interests of shareholders.
How to buy and sell REITs
- You can invest in a publicly traded REIT listed on a major stock exchange by purchasing shares through a broker.
- You can purchase shares of a non-traded REIT through a broker that participates in the non-traded REIT’s offering.
- You can also purchase shares in a REIT mutual fund or REIT exchange-traded fund.
Understanding fees and taxes
Publicly traded REITs can be purchased through a broker. Generally, you can purchase the common stock, preferred stock, or debt security of a publicly traded REIT. Brokerage fees will apply.
A broker or financial adviser typically sells Non-traded REITs.
Non-traded REITs generally have high up-front fees. Sales commissions and upfront offering fees usually total approximately 9 to 10 percent of the investment. These costs lower the value of the investment by a significant amount.
Special Tax Considerations
Most REITS pay out at least 100 percent of their taxable income to their shareholders.
The shareholders of a REIT are responsible for paying taxes on the dividends and any capital gains they receive in connection with their investment in the REIT.
Dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends.
Consider consulting your tax adviser before investing in REITs.
Are you considering your options for investing in a REIT?
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Safe Storage USA has provided this information from Investor.gov as a service to investors. It is neither legal advice, interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney specializing in securities law. Safe Storage USA is not affiliated with Investor.gov