The following is a post written by Luke Babich, a guest contributor to the DealCheck blog.
If you’ve always wanted to invest in real estate but hate the idea of managing renters or handling maintenance, you might be interested in a real estate investment trust, commonly abbreviated as a REIT.
A real estate investment trust is a pool of money from several different investors. Instead of using their own money to buy a small rental house, several investors combine their money into a fund for a big purchase, such as an office building, apartment complex, or other real estate property.
If a REIT is publicly traded, you can buy shares of it on a stock exchange, just like any other stock or mutual fund. You can also sell your shares, which is a much quicker process than trying to list a house, prepare it for sale, and have several open houses.
There are many different types of real estate investment trusts. They all do roughly the same thing — manage multiple property investments — but they are slightly different in terms of how they manage and select the type of real estate they invest in. It’s important to learn the pros and cons of each trust prior to investing, so you can choose the best investment for you and your risk tolerance level.
Advantages of REITs
Real estate investment trusts have built-in diversification. First, you’ll own a share of multiple pieces of real estate, rather than just one. Additionally, a REIT might include properties from various industries, such as healthcare buildings, apartment complexes, grocery stores, or other commercial buildings. These investments might be spread across the US or across the globe as well.
The benefit of having a diverse real estate portfolio is that if one industry or geographic area struggles, there are still many other real estate holdings in the trust to offset any losses.
REITs are a great option for relatively new investors who might not have the funds to pay large down payments on investment properties. If REITs are public and traded on the open market, individual investors can purchase shares of them. Many of these shares are available for less than the price of a pizza.
However, there are private REITs, called non-traded REITs, that have a higher barrier to entry. Many of these opportunities are only available to accredited investors (those with high incomes or large amounts of assets).
REITs are also liquid, meaning you can sell your shares in the stock market if you no longer want them. By contrast, selling physical real estate can be tricky, depending on market conditions. It can take months to sell a piece of property. For that reason, many investors appreciate how straightforward it is to buy and sell REITs.
Real estate investment trusts pay dividends to their investors. Although no investment is guaranteed, this can create consistent passive income. There are also tax benefits to the structure of these trusts, which are typically considered corporations.
Disadvantages of REITs
Investing in real estate comes with risks because the success of the market largely depends on macroeconomic factors beyond your control. If there are changes in interest rates or other economic conditions, it could negatively affect the assets in the trust.
Real estate investment trusts follow a specific real estate index or are actively managed. As an individual investor, you don’t have control over what the managers select in their actively managed funds. You have to research and decide if the underlying investments in each trust are properties you believe will yield a positive return.
How to Get Started Investing in REITs
Although REITs can be a great investment option for many, they do come with risks and drawbacks. It’s important to know about these pros and cons before investing. Before you start, take these steps.
1. Educate Yourself
It’s important to do as much research as possible before you start investing. There are many different types of REITs, such as triple-net REITs, paper clip REITs, index fund REITs, and REIT exchange-traded funds, among others. The amount of information about REITs and the investment market might be overwhelming at first, but it’s something you can learn and understand with time.
2. Know Your Risk Tolerance
Everyone has a different risk tolerance. Some investors prefer to make conservative investments, while others are more comfortable taking risks if it could lead to higher returns. Some investors are more aggressive when they are younger and more conservative when they get older. There is no right or wrong way to invest, but it’s important to know where you stand so you can make knowledgeable investment decisions.
3. Select a Broker
To invest in a REIT, you have to purchase shares through a broker or brokerage company. Many low-cost brokerages operate online and have been in business for decades, earning a solid reputation.
Opening a brokerage account is similar to opening a bank account. You’ll need to fill out an application to open the account and provide some identifying information, such as your name and social security number.
The difference between a brokerage account and a bank account is that with a bank account, you usually keep your money in cash in a checking or savings account. With a brokerage account, you use your money to invest in securities, such as stocks, bonds, or REITs.
4. Monitor Your Investments
Once you’ve invested in a real estate investment trust, it’s a good idea to monitor your investments. It’s normal for the value of assets to fluctuate over time, but it’s a good idea to evaluate your holdings, become familiar with the securities you own, and track their progress.
Final Thoughts – Are REITs Right for You?
Many people want to start investing in real estate, but they worry they don’t have the cash to get started. Traditional real estate investing typically requires paying for a down payment, closing costs, insurance, and maintenance issues as they arise.
That’s why, for many people, investing in a real estate investment trust is a good alternative. By investing in REITs, individuals can still invest in real estate without the hassle and stress of handling maintenance calls.
Of course, investments come with risk, and potential REIT investors need to do their homework and understand the investment before opening a brokerage account and purchasing their first REIT share.
Luke Babich is a licensed real estate agent and is the co-founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers and investors make smarter financial decisions.