What Are REITs? Real Estate Investment Trusts Explained

Real Estate Investment Trusts (REITs) offer individual investors an accessible way to invest in real estate without the need to purchase or manage properties directly. These entities own, operate, or finance income-producing real estate assets, distributing profits to shareholders in the form of dividends.

In this article, we´ll explore what REITs are, how they work, the different types available, the benefits and risks of investing in them, and how to incorporate them into your investment portfolio.

What Are REITs?

A Real Estate Investment Trust (REIT) is a company that owns, manages, or finances real estate that generates income. These companies pool money from investors, allowing them to collectively own a portfolio of properties such as office buildings, apartments, hotels, or retail spaces.

By law, REITs must distribute at least 90% of their taxable income to shareholders, making them a popular choice for income-focused investors.

How Do REITs Work?

REITs generate income primarily through rent collected from tenants or interest on the properties they finance. Publicly traded REITs can be bought and sold on major stock exchanges, offering liquidity that is uncommon with direct real estate investments.

REITs are professionally managed, so investors do not need to worry about property maintenance or tenant management. The returns come in the form of dividends and potential appreciation in the REIT´s stock price.

Types of REITs

REITs can be broadly categorized into three main types:

Equity REITs: These focus on owning and operating income-producing properties. Examples include residential complexes, shopping centers, and office buildings.
Mortgage REITs (mREITs): Instead of owning properties, mREITs provide financing for real estate and earn income from interest on loans.
Hybrid REITs: These combine elements of both equity and mortgage REITs, owning properties and investing in mortgages.

Benefits of Investing in REITs

Consistent Income: REITs offer regular dividend payments, often higher than what traditional stocks provide.
Liquidity: Publicly traded REITs can be easily bought and sold on stock exchanges.
Diversification: Adding REITs to your portfolio provides exposure to real estate, reducing reliance on traditional assets like stocks and bonds.
Low Barrier to Entry: Investors can gain access to high-value properties without needing significant capital.

Risks of Investing in REITs

Market Volatility: Publicly traded REITs can experience price fluctuations similar to stocks.
Interest Rate Sensitivity: REIT prices often drop when interest rates rise, as higher rates make borrowing more expensive.
Sector-Specific Risks: Some REITs are tied to specific sectors like retail, which can face challenges like e-commerce competition.

Adding REITs to Your Portfolio

To diversify your portfolio, consider including REITs or REIT-focused ETFs. Start by researching well-known REITs with strong track records and focus on sectors that align with your risk tolerance.

Want to learn more? Read our article on Portfolio Diversification.