Real Estate Investment Trusts (REITs) are a great way for investors to diversify their portfolios and to receive dividend income. Because of their lower correlation to the broader stock market, wealth managers have utilized REITs to dampen volatility in client portfolios for many years.

What are Real Estate Investment Trusts (REITs)?

Real Estate Investment Trusts (REITs) are companies that own, operate, and/or finance real estate properties that are income-generating. REITs accomplish this by using the pooled capital of investors (a minimum of 100 investors or shareholders by the end of the first taxable year).

REITs were originally created in the 1960s as a means of providing investors with access to commercial real estate products. Prior to that, commercial real estate was only available to institutional investors. REITs are companies that own and operate real estate and real estate-related assets. They can cover a broad range of sectors and provide investors with access to assets such as office, hospitality, industrial, multifamily, storage, mortgages or loans––even timber. Their prominence didn’t really take hold until the early 1990s after the Tax Reform Act of 1986 was passed. This legislation provided REITs with the ability to operate their assets rather than just owning or financing them.

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) Investment Benefits

One of the most important benefits is that a REIT pays no corporate tax. Now, there are strict guidelines for this provision such as minimum investment requirements and dividends. REITs must invest at least three-quarters of their total assets in real estate and pay 90% of all taxable income to shareholders in the form of dividends to keep their qualifications as a REIT.

Other benefits of REITs include:

  • Liquidity – Unlike owning physical real estate properties that are illiquid, REITs provide investors with daily liquidity. That means you can buy and sell shares of any REIT on the same day. There are no long-term holds or minimum investment requirements.
  • Diversification – Many wealth advisors view REITs as an important role in stock portfolios because of the diversification they can offer to investors. One can invest in REITs that have multiple sectors represented under one umbrella thereby offering instant diversification.
  • Attractive Historical Returns – Historically, REITs have outperformed the S&P 500 over the last 20 years. They are required to pay 90% of their revenue in the form of dividends which are often higher than most other investments.
  • Transparency – REITs must adhere to certain regulations, which include reporting financial performance quarterly and annually. This provides investors with detailed insight into what the REITs are investing in, any and all expenses paid to third parties such as property managers, property level vacancy rates in the portfolio, detailed rates of return achieved, properties sold and for how much, the price per square foot, etc.

REIT Investing Drawbacks

Held for long periods of time, REITs have proven to provide investors with favorable risk-adjusted returns when compared to the S&P 500. But like all other investments, REITs have their drawbacks too.

Some of these include:

  • Long-Term Growth – REIT’s are generally like cooking briskets…low and slow. Ok, well maybe that’s a bad analogy, but you get our point. REITs are subject to the short-term volatilities of the market. Studies have shown that REIT investments have the best return profile when held for long periods of time. If you’re looking for short-term returns, you might want to look elsewhere. Most investors invest in REITs for their long-term growth potential and dividends.
  • Market Risk – All stocks are subject to market risk! Because stocks are liquid investments, people tend to play with their emotions rather than their logic which causes all stocks, including REITs, to have a certain level of volatility when navigating periods of uncertainty.
  • Sector-Specific Risk – When Covid hit the U.S. in the first quarter of 2020, Hospitality REIT performance literally fell off the face of the earth. Consumers and businesses on a global scale stopped traveling and hotels were instantly affected. Many large-scale property owners were forced to shutter their doors, lay off employees, and work with lenders on loan deferment programs. Fast forward seven months later and hotels are still operating at occupancy levels that are below their ability to service debt. All hospitality-focused REITs lost massive value overnight with many suspending their dividends.
REITs include Hotel Investment Opportunities

With disruption comes opportunity.

Watch to see how hospitality is the first to rebound after periods of economic instability.

WATCH VIDEO
  • Interest Rate Sensitivity – Rising interest rates typically have a negative impact on REIT performance. When interest rates rise, REITs tend to have lower dividend yields due to their interest rate expense increasing. Low-interest rate environments are favorable for yield-focused investors.
  • High Fee Structures – Some REITs have egregious fee structures that can significantly detract from investor returns. Doing your research and understanding how the management teams are incentivized is important.

Final Thoughts

Like any investment vehicle, REITs have their advantages and disadvantages. But just about any way you look at it, it’s easy to see that REITs can be a great way to get exposure to the real estate industry. That’s why they are often used in conjunction with other strategies such as direct private equity real estate. Combining strategies helps to offset market correlation/volatility and creates a better risk-adjusted balance for investors –– all without compromising the benefits of passive income, tax benefits of depreciation, and the appreciation that private equity real estate provides. To learn how private equity real estate can benefit your portfolio, click here to get started.