Alternative Investing: How to Invest in REITs

February 7, 2023 Beginner
A real estate investment trust (REIT) is a security that offers an opportunity to invest in real estate properties. Learn how you can incorporate REITs into your investing strategy.

Long before the stock markets existed, investors had a fixation on land. After all, as the old saying goes, they're not making any more of it. There's also a limit to what you can put on land (houses, skyscrapers, shopping malls) and get out of it (grain, gold, oil, wood).

Real estate investment trusts, or REITs, first emerged in the 1960s to provide individual investors with a way to invest in real estate. For a long time they tended to fly under the financial media and investing radar. More recently, many market professionals have turned to REIT for diversification, perceived inflation protection, and income.

What is a REIT, and how does REIT investing work? At its most basic, an equity REIT is a holding company that owns income-producing properties, such as apartment buildings or commercial strip malls. Shares of REITs often, although not always, trade on major exchanges.

As of 2023, "REITs own approximately $4.5 trillion worth of gross U.S. real estate assets, with more than $3 trillion of that totally from public listed and non-listed REITs and the remainder from privately held REITs", according to Nareit data, a research and lobbying group based in Washington, D.C.

Here are some basics of how to invest in REITs. We'll look at a few REIT sectors linked to specific sectors such as healthcare, retail, residential, and infrastructure.

Potential benefits of REITs vs. traditional stocks?

Many REITs are registered with the SEC and some of their shares trade publicly, like other stocks. This gives investors the option to diversify by investing in real estate while still holding a liquid asset, as opposed to a physical piece of real estate. In the U.S., the IRS requires the trusts to distribute 90% of their taxable income each year, so REITs often pay out higher dividends than stocks or bonds, making them potentially good income investments 

Additionally, when inflation rates are rising, REITs can sometimes be a hedge against rising rates because REITs with commercial holdings may hold the ability to increase the rental costs to match the rising rates. Lease lengths are important for determining how cyclical a property type is. For example, office properties, with their long lease terms, are typically pro-cyclical. When businesses are growing and adding more people to support that growth, they are likely to lease more space. When growth is more challenging, fewer businesses will look to expand their office footprint and may instead be shrinking.

How does the performance of REITs compare with stocks?

In general, the REIT market can see periods of outperformance versus the broader stock market. However, the sector can also see periods of intense volatility. For example, in the early 2000s (a period which many called a real estate bubble) the Dow Jones Composite All REIT Index ($RCI) outperformed the S&P 500® index, but the sector was hit particularly hard during the ensuing financial crisis in 2008 – 09.

What about REITs' correlation with interest rates and the broader economy?

When the U.S. Federal Reserve Bank' starts hiking interest rates, the market can sometimes start to look bearish for REITs, as rising rates can mean higher borrowing costs. REITs tend to benefit from economic growth, which supports rent collections and property prices; but most REITs borrow heavily, making them extremely vulnerable to rising interest rates.

A breakdown of REITs sectors

Retail and office REITs: These partnerships own and manage real estate devoted to shopping malls, office buildings, strip malls, big-box stores, and the like. They rent space in those properties to tenants.

Considering the recent struggles of traditional retailers, investors should proceed with caution, analysts say, as the growth of e-commerce has created upheaval in the retail real estate market.

Health care REITs: Growth in both the U.S. senior population and demand for medical services signals continued strength in health care REITs, some market professionals say.

Similar to their retail counterparts, healthcare REITs own and manage a variety of properties and collect rent from tenants. These properties include senior living facilities, hospitals, medical office buildings, and skilled nursing facilities. 

Residential REITs: These partnerships own and manage a wide range of residential housing properties including multi-family apartments, duplexes, student housing, and even single-family residences.

REIT angles on e-commerce: Data center, industrial, and infrastructure categories are among the top-performing REIT sectors in recent years, reflecting growth in e-commerce, according to Nareit. Infrastructure REITs include cell towers used to relay e-commerce orders, while industrial REITs include warehouse distribution and logistics facilities for e-commerce goods, while data center REITs own and manage facilities that customers use to safely store reams of data. Taken together, data center, industrial, and infrastructure categories form a synergistic "triad" for the e-commerce economy.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and credit worthiness of the issuer.

Investing involves risk, including loss of principal.

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