Real estate investment trusts or ‘REITs’ provide you with a unique way to invest in property. The main selling point is that you don’t have to buy a house or become a landlord.
REITs have become a portfolio staple for savvy income investors over the past decade. But what exactly are they and how can you invest in them? This guide will explain how they work and why REIT shares can be such a useful investment to hold onto.
Keep reading to find out all the details on how you can easily become a property mogul, or click on a link to jump straight to a section…
- What is a REIT?
- How they work
- Different types of REITs
- Are they a good investment?
- Risks and disadvantages
- How to invest
- What else investors need to know about REITs
What is a REIT?
This is a company that owns and manages various types of properties. Because REITs are set up as a normal company, it means you can buy shares just like you would with other stocks.
Owning large pieces of residential and commercial real estate is often reserved for those with deep pockets. But, REITs provide a much simpler way for ordinary investors to become property owners.
One of the best things about them is that you don’t need a mortgage or piles of cash to invest.
REITs have been a popular way to invest in property since the 1960s in the US. Here in Britain, we’re a little bit behind and they only became accessible through the London Stock Exchange (LSE) since 2007.
How do REITs work?
The unique structure provides some exciting opportunities for investors.
There are certain criteria that a stock has to meet to be classified as a REIT in the UK, the company must:
- Be a UK tax resident.
- Distribute at least 90% of income profits as dividends to shareholders.
- Trade on a recognised stock exchange.
- Have at least 75% of gross assets and 75% of profits come from property rentals.
- Not be a closed company, meaning it can’t be controlled by five or fewer investors.
What are the different types of REITs?
Just like there’s a flavour of ice-cream for just about everyone, there’s probably a REIT too.
REITs invest in all sorts of property and some of the most popular and lucrative areas include:
- Office buildings
- Data centres
- Hotels and restaurants
- Healthcare facilities
- Shopping centres
Usually, REIT investments fall into two main categories – equity or mortgage:
- Equity REITs – generate most of their profit from rent on buildings such as shopping centres, offices, hotels, and warehouses.
- Mortgage REITs – hold both residential and commercial property assets. Most of the profit is from interest earned on mortgage investments.
Is a REIT a good investment?
They certainly can be. But, there’s a lot of variety within the types of REITs available to investors.
Here’s a quick breakdown on the top advantages of investing in property this way:
1. Easy access for buying and selling real estate
Because you can buy and sell shares on exchanges, this makes it a fairly liquid investment. And much easier to own than physical property.
2. More affordable than buying property
With a REIT, you get to own shares in a portfolio containing many properties, without having to shell out loads of money for the opportunity.
3. Extra diversification for your portfolio
Investing in property and real estate can be a great way to hedge against inflation and give your investment portfolio some extra oomph with brick and mortar.
4. Access to unusual areas of property
Even if you’re already a landlord or a wannabe Donald Trump property mogul, REITs allow you to access complex areas of real estate that you’d struggle to invest in by yourself.
5. Solid income from dividends
Some of the properties owned by REITs are bonafide moneymakers and you get a share of the profits. Plenty of REITs have excellent track records for rewarding investors with a steady income of dividends.
What are the risks and disadvantages of investing in REITs?
This particular way of investing isn’t without its drawbacks. Here’s an explanation of some of the major points you need to be aware of:
- Property market risks: the real estate market marches to the sound of its own drum. And, depending on what kind of property your REIT owns, this can present some unusual risks. Just like with stocks, there can be volatility, crashes, and even global pandemics that shut down buildings around the world. For example, recently those with large holdings in office blocks, retail outlets and even factories have seen a marked drop in their income.
- The investing cost: REITs are managed by a team of professionals, which can be good for performance. But, it also means the people running the show take a slice. Some fees in this sector can be quite high compared to other types of investments like passive index funds. Be very careful about management fees as studies show that the amount you pay in annual fees can have a marked impact on your returns in the long-term.
- Liquidity risks: although this is a much more liquid way to own property than directly investing into bricks and mortar, the REIT market doesn’t attract the same sort of volume as regular stocks and shares in companies. This can make it more difficult to shift your shares in a downturn.
- Leveraging: UK REITs can borrow up to 25% of their holdings to try and maximise returns. But, this can also lead to a magnification of losses when times are bad. Be careful.
How do you invest in REITs?
You’ll need to make sure you’re set up with a brokerage account that gives you access to a wide range of investing options.
REITs are fairly mainstream, but not every broker will let you invest. Using a multi-asset platform like eToro can be an excellent way to get exposure to lots of different types of investments.
If opening an account seems too confusing, here’s a walkthrough on how to open an account and buy shares with eToro.
Once you’re set up on a platform, here’s a step-by-step guide for buying REITs:
- Research the type of REIT you’d like to invest in.
- Decide whether you want to buy an individual REIT or an ETF (exchange-traded fund).
- Choose your option and decide how much you’d like to invest.
- Put the code for the REIT into the ‘buy’ section on the page of your online broker account.
- Buy your shares and pat yourself on the back as you now own property.
You can also use certain stocks and shares ISAs to invest in and hold REITs. Doing this will help protect any growth or dividend income from tax. Meaning you get to keep more of the profit!
Many online brokers offer self-select ISA packages so if you open one of those you can slot in your REIT as and when you invest in it.
What else do investors need to know about REITs?
Although this can be a fantastic way to own some property and generate income, it’s still vital you do plenty of research before picking a REIT to invest in.
Finding the best REITs available can be tricky. If you’d like some broad exposure at a cheap cost, I’d definitely recommend looking into ETFs.
These funds can give you access to multiple REITs, even hundreds, with one single investment.
If you’d like to stay up to date with all the latest market movements and investment news, make sure you sign up to the MoneyMagpie fortnightly Investing Newsletter.
This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.
Worth more reseach.