Investing in Real Estate Investment Trusts (REITs)
Get a better understanding of what REITs are and considerations for incorporating them into your trading or investing strategy.
A Real Estate Investment Trust (REIT) is a security that trades like a stock on the major exchanges and owns—and in most cases operates—income-producing real estate or related assets. 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. REITs receive special tax considerations and typically offer investors high dividend yields, as well as a liquid method of investing in real estate.
REITs, which are structured as a corporation, are not typically taxed at the entity level, which allows investors to avoid double taxation on dividends. REITs must invest in real assets and derive the majority of their income from real estate activities, including rents from properties and interest from mortgages. The REIT must also pay out 90% of its annual taxable income in dividends. Due to this structure, they typically pay out a higher rate of dividends than equities or many fixed income investments. Dividends received from REIT holdings are taxed as regular income.
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Benefits and risks of REITs
Benefits of REITs
Potential for higher yield
REITs typically pay higher dividends than common equities. REITs are able to generate higher yields due in part to the favorable tax structure. These trusts own cash-generating real estate properties.
REITs are typically listed on a national exchange and provide investors considerable liquidity. These securities invest in a portfolio of commercial real estate assets that are not typically available to retail investors.
REITs can provide diversification benefits because they tend to follow the real estate cycle, which typically lasts a decade or more, whereas bond- and stock-market cycles typically last an average of roughly 5.75 years.
REITs can serve as an effective hedge against rising inflation rates. In particular, REITs with commercial holdings frequently have agreements that allow them to raise rents in tandem with inflation.
Risks of REITs
Real estate risk
REITs closely follow the overall real estate market and are subject to much of the same risks, including fluctuations in property value, leasing occupancy, and geographic demand.
Interest rate risk
Real estate is typically very sensitive to changes in interest rates, which can affect property values and occupancy demand.
Occupancy rate risk
In order to maintain the expected payouts, REITs must maintain certain occupancy levels. This closely ties in with the amount of rent that these properties are able to command. Lower rents and occupancy rates may negatively impact REITs.
REITs can have a narrow geographic focus where the majority of the property is located in a particular area or region.
REITs can be highly susceptible to the underlying business or industry that leases the properties.
Schwab's perspective on Real Estate Investment Trusts
REITs offer a number of attractive attributes such as growth, income, and diversification. REITs have historically delivered strong results and provide attractive income relative to other asset classes. They offer diversification relative to traditional investments like stocks and bonds. Historically they have also been a good hedge for inflation; however, they are often low-growth investments with little capital appreciation.
There are two main types of REITs: Equity and Mortgage. Within Equity REITs, there are subcategories based on the types of properties held in the REIT.
Common types of REITs
Own and manage properties and collect payments from tenants.
Own and operate a variety of commercial properties such as shopping malls, office buildings, and data warehouses. They generate income from rents received from tenants.
Own and operate a variety of residential housing properties. These include multi-family apartments, student housing, and even single-family homes.
Own and operate properties that focus on the healthcare industry including, hospitals, medical centers, and nursing facilities.
Invest in mortgages and derive their income from interest payments.
Your approach to investing in REITs depends on what type of investor you are. Some investors may want to invest in an exchange-traded fund or mutual fund that tracks a broad-based REIT index rather than investing in individual REITs. You can buy and sell REITs on your own with a Schwab One® brokerage account or call us at 877-566-0054 to talk to an experienced specialist about whether REITs are right for you.
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