The thought of owning multi-million-dollar commercial properties like large apartment complexes, multi-story office buildings, shopping malls, and hospitals is impossible for most real estate investors.
Many investors do not have the money or resources to purchase and manage these properties. Yet, there is a type of investment that allows small retail investors to gain exposure in the commercial real estate market.
This article will give you a general overview of REITs, how they compare to owning actual real estate, and how they perform as long-term investments.
Hopefully, you will find inspiration to look further into REITs and add them to your portfolio.
What are REITs?
Real Estate Investment Trusts, or REITs, purchase, own, operate and sell income-producing properties. REITs give investors access to the cash flow that income-producing properties generate.
Investors do not have any direct involvement in owning or managing these properties. Anyone can purchase shares of a REIT company on the stock exchange, and you can also buy shares of REIT mutual funds and ETFs.
REIT companies own and operate all types of income-producing real estate. REITs primarily focus on commercial real estate, but some REITs focus on single-family residences.
Many REITs specialize in one kind of property, such as apartments or hospitals. Other REITs may have a diversified portfolio of two or more types of properties. REITs can specialize in properties in one or more cities or states, and some U.S.-based REITs own and manage properties around the world.
The History of REITs
In 1960, President Dwight D. Eisenhower signed into legislation a bill that created a new asset class that combined the benefits of real estate and stock market investing.
This legislation allowed small retail investors to gain access to commercial properties that were once only available to wealthy individuals and institutional investors like banks and brokerage firms.
This legislation allowed REIT companies to own and finance commercial properties while third-party property management companies managed and operated these properties.
The Tax Reform Act of 1986 changed this situation. The Tax Reform Act allowed REIT to own, finance, manage and operate commercial properties without using a third-party property management organization. This Act created the modern REIT that still exists today.
The first six REITs began their operations from 1960 to 1961, and two of these REITs still operate today. These are:
- Bradley Real Estate Investors
- Continental Mortgage Investors
- First Mortgage Investors
- First Union Real Estate, later known as Winthrop Realty Trust
- Pennsylvania REIT – (NYSE ticker symbol PEI – retail shopping malls and department stores)
- Washington REIT – (NYSE ticker symbol WRE – diversified office, retail, and multi-family housing)
Today, there are about 1,100 REITs around the world, including 225 registered REITs in the U.S. Most of these 225 REITs trade on the NYSE.
There are several categories of REITs. These categories include:
Properties range from metropolitan skyscrapers to suburban office parks.
Properties include warehouses, distribution centers, and manufacturing facilities.
These REITs have malls, outlet centers, grocery store-anchored shopping centers, and big-box stores in their portfolio.
Properties include hospitals, medical offices, senior living facilities, and skilled nursing facilities.
These companies own facilities that safely store data.
These REIT companies own and operate hotels, motels, and resorts.
Properties include apartments, student housing, multi-family homes, manufactured homes, and single-family homes.
These companies own and manage storage facilities.
These REITs own land where they harvest, process, and sell timber.
These REITs own property with fiber-optic networks, telecommunication towers, outdoor advertising.
These REITs own and operate movie theaters, casinos, farmland, and other unique properties.
These REITs own and operate a mix of two or more of the above properties.
These companies do not own or manage properties. Mortgage REITs, or mREITs, invest in mortgages, mortgage-backed securities, and other mortgage-related assets.
Are MLPs Considered REITs?
Master Limited Partnerships are beyond the focus of this article, but they do deserve a brief mention. MLPs are oil, gas, chemical, and green energy companies.
These companies own and operate storage facilities, processing plants, transportation facilities, pipelines, land, and other energy-related entities. Anyone can purchase shares of MLP companies.
MLPs are a separate category from REITs, even though they share some things in common. If MLPs were REITs, they would be in the industrial REIT category.
The Benefits and Drawbacks of Owning REITs
REITs can add income and growth to your portfolio. There is no such thing as a perfect investment, yet having REITs can diversify your portfolio to help protect your assets from the uncertainties in the economy. Here are a few benefits of owning REITs that you should know about:
REITs must meet several strict requirements. One of these requirements is to distribute at least 90% of its taxable income to shareholders. REITs do not pay any corporate taxes when they meet this and other requirements.
This is a benefit to investors who are looking for current income. REITs pay higher than average dividend yields because they must distribute at least 90% of their taxable income to shareholders.
It is not unusual for a REIT to have a safe dividend yield of 8%. The average dividend yield for a stock on the S&P 500 is around 2%. Many REITs pay a monthly dividend, which is another benefit for income investors.
- Access to Commercial Real Estate
REITs allow small retail investors to gain the benefits of owning a piece of multi-million-dollar, income-producing commercial properties at a minimal cost.
It can take several months or years to sell multi-million-dollar commercial properties. Thankfully, you can buy or sell REIT stocks in seconds with a click of a button.
The Drawbacks of Owning REITs Include:
REIT dividends are taxed as ordinary income compared to dividends from other types of stocks. This means REIT dividends are taxed at a higher rate than dividends from other stocks.
- Sensitivity to Interest Rates
Rising interest rates harm REIT stock prices. There is a direct correlation between the 10-year Treasury yield and the US REIT stock price index. When the 10-year Treasury yield goes up, the US REIT stock price index goes down and vice versa.
- Risks to Specific Properties
Many REITs focus on owning and managing one type of property. This can harm the stock price and dividend payments. For example, lodging/resort REITs were hard hit by the COVID- 19 pandemic during 2020.
These REITs saw a significant drop in stock prices, and many had to temporarily reduce or suspend their dividend payments. Skilled nursing and senior living facility REITs were also hit hard during this time because the pandemic heavily impacted the elderly population.
Retail, specialty, and skilled nursing/senior living health care REITs were also heavily impacted by the COVID-19 pandemic.
Are REITs a good long-term investment?
You may now be wondering if REITs are a good long-term investment. All indicators show REITs as being excellent investments for long-term growth.
Past performance cannot predict future growth, but REITs have outperformed the broader stock market when you look at monthly returns for at least the past 15 years.
REITs also outperform 11 out of 12 asset classes for over 20 years, including privately held real estate. The only asset class that REITs did not outperform over the past 20 years was private equity.
In addition to privately held real estate, REITs outperformed stocks, bonds, hedge funds, and other assets like precious metals, natural resources, and commodities for over 20 years.
REITs are suitable for:
- Long-term, buy-and-hold investors with financial objectives of 10 or more years
- Investors seeking stable and consistent monthly or quarterly income
- Investors who have 15 years or more until retirement
- Investors who cannot afford to buy commercial properties
- Investors who do not want to own and manage residential or commercial properties
REITs may not be suitable for:
- Short-term day or swing traders
- Investors who prefer capital appreciation over current monthly or quarterly income
- Investors who want the income and tax advantages of owning investment properties
Are REITs Good Long Term Investments? I would love to hear from you. Please send me your comments about your experiences investing in REITs, the type of REITs you prefer, are good and how REITs have helped to diversify your portfolio.
Thank you and have a great day.