REIT Investing

For most real estate investors, sole ownership of an office building, a local shopping center, a warehouse, or even an apartment complex is a dream that will go unrealized. There is however an investment model that allows smaller investors to engage in the real estate marketplace by purchasing an interest in those types of properties, without the hassle of management responsibilities, while also providing great potential for a passive income. Those vehicles are known as real estate investment trusts (or REITs). REITs were created in 1960 by Congress and allow people to invest in a various types real estate, depending on the type of property a particular REIT specializes in. REITs often consist of a wide range of real estate including apartments, hotels, office buildings, assisted living facilities, retail space, industrial space and more worldwide. They are required by law to be widely held and to distribute most of their income as dividends to shareholders. REITs are considered to be a very liquid asset, largely due to the fact that investors can purchase shares on the stock market.

Equity vs mortgage REITs

Ninety percent of all market capitalization in the REIT industry is focused on equity REITs, according to the National Association of Real Estate Investment Trusts (NAREIT). The typical REIT is will specialize in owning specific kinds of properties. Investors' capital is pooled together and then the REIT's management team purchases the type of properties the REIT specializes in. A majority of the REIT's income is distributed to shareholders as dividends, after expenses are paid. Dividend distributions will also include the capital appreciation from the sale of properties.

On the other side are mortgage REITs. Investors in this model put their money into the debt financing facet of the business. Mortgage REITs invest in real estate mortgages (primarily single-family residential loans) or mortgage-backed securities. The income earned from mortgage REITs will come from the interest paid on the investments and the sale of mortgages.

Long-term returns

The decision to choose an equity REITs or mortgage REITs is one that should be based on the investor's specific goals and strategy. Buying shares of REITs is a more conservative play that has the proven potential for a more sustainable rate of return, albeit over a long period of time, unlike the quick double-digit rates of return investors are accustomed to as either owners of rental units or as flippers. Over the past 25 years, equity REITs based in the U.S. have outperformed the Standard & Poor's 500 index in terms of income and total returns combined, according to data compiled by NAREIT. For the last 20 years, listed equity REITs had an average total return of 12.14% per year without the reinvestment of dividends. When dividends were reinvested, they yielded an average total return of 17.60% per year. For investors who are looking for a stable income stream to assure they have money available for retirement, long-term yields will be a vital factor.

Economic factors are important to valuation.

Like many other investment products, the value of REITs – and their return on investment – are largely tied to economic factors such as interest rates, inflation, unemployment, and numerous other economic factors. The average real estate cycle is much longer than the average stock market cycle (four years for the stock market versus 18 years for real estate). So while the nation's overall economy does have an impact on the market for REITs, it is recommended that investors have a well-diversified exposure to the real estate cycle and that REITs be a part of every portfolio. Due to the fact that a lot of REITs have no minimum buy-in, investors have the benefit of being able to start out small.

Options for selecting REITs

For investors who like to be actively involved in selecting assets and managing their own portfolio, they have the ability to select and buy shares of REITs individually through a stock broker, financial advisor or financial planner. Whether their interest lies in retail malls, storage units, multi-family apartments, or commercial property, for an experienced investor, REITs offer an opportunity to actively manage a diverse portfolio. For those investors who are not as confident in selecting specific REITs or property types, there is the option to buy as many or as few shares as they want through either a mutual fund or an exchange-traded fund, such as those available through Vanguard, JPMorgan Chase & Co., or Fidelity along with numerous other providers. Investors also have the option of selecting actively managed funds that extensively research the REIT market. These funds will strive to build portfolios of REITs that will outperform the market. Regardless of which way an investor decides to go when choosing REITs for investment opportunities, it is always a good idea to get a financial advisor involved to address any concerns before putting up the money.