Real Estate Investment Trusts(REITs): A Complete Guide

Investing these days is not limited to mutual funds, fixed deposits, and old school real estate. There are many new ways to invest your money and one of them is via REITs. REITs or Real Estate Investment Trusts are the new definition of investing that have revolutionized the way people see real estate as an investment. This method takes care of all unnecessary landlord problems you may face otherwise when buying a wholesome property, and offer the benefits of investing in real estate. Here’s what you must know.

What is REIT?

REIT is a type of investment instrument that invests the pooled money from several investors into a portfolio of profit-generating real estate assets like hotels, resorts, shopping malls, serviced apartments, commercial buildings, and offices.

Just like mutual funds, these real estate assets are also managed professionally and the profits generated from them are distributed among the shareholders in the REIT scheme after deducting the property management fee, maintenance fee, or any other applicable fee. The primary source of profit generation in the case of REITs is the rental income that is generated from the assets.

These are best suited for investors looking forward to a long-term investment that generates consistent and reliable returns. Although all investment types are subject to market trends, REITs are among the very few that are marginally affected since it invests in properties that are rented throughout the year under any circumstances.

How to invest in REITs?

Investing in REITs is quite similar to investing in stocks or bonds. You can contact your broker or simply buy the shares of REIT online through various BFSI (banking, financial services and insurance) platforms.

REITs are essentially modelled around mutual funds, and have similar features and processes revolving around the idea of generating consistent and reliable returns in the form of dividends, as in case of mutual funds. The major difference lies in the underlying assets, which in case of REITs is real estate property.

What is the working structure for REITs?

As mentioned above, since REITs are framed around mutual funds, the process flow is also quite similar to them. The following steps explain how they work:

Step 1: Money from various investors is gathered through IPOs and direct stock purchases which are then invested into rent generating real estate properties.

Step 2: The acquired properties are rented out to tenants or leased out for a given period.

Step 3: Depending upon the contract, rental income flows in which is generally on a monthly basis. This rental income is distributed among the investors after securing the operational costs.

Operational costs of REITs include the management cost charged by professionals who take care of the properties, maintenance cost, and trustee commission, etc. Also, depending upon the location of the property, taxation may also vary for several REITs which is also deducted from the rental income.

Here are 7 things you need to know about REITs before jumping in:

1. Excellent diversification tool

Of the many benefits of investing in REITs, the biggest one is its diversifying properties. As a general rule of thumb, it is always better to have a well-diversified portfolio across different instruments and industries. Investing in REITs is one such investment decision that can provide consistent returns and stays almost neutral to market fluctuations.

2. Offers multiple options

Similar to investing in mutual funds, REIT investment also comes with a lot of options to choose from. The investments are essentially made into different types of real estate properties that typically generate returns.

You can choose to invest in apartments, commercial spaces, offices, family houses, industrial areas, townships, shopping malls, market areas, hospitals, hotels, financing properties, net lease, etc.

All these options are characterized by their own risk and return set that needs to be understood before investing. For example, residential rentals generally stay consistent but depending on how the economy fares, related industries like travel or hotel can get affected, reducing the productivity and profitability of the hospitality industry and hence the rentals.

3. REIT variants

Most investors are unaware of the fact that REITs are of two types- eREITs and mREITs. While eREITs are commonly referred to as simple REITs, these are equity REITs that basically function upon owning the real estate property and renting it out. mREITs stands for mortgage REITs that are services related to the REITs industry like financing. The investments are primarily made in financing securities and the profit is made from the interest earned on them which is then distributed among the investors as dividends. mREIT is framed around a bank structure taking care of the financial needs of the industry.

4. Management style

Investors need to manage REIT investments in order to take care of the investment proceeds. There are two ways in which a REIT can be managed – internally and externally. In an internally managed style, the employees and management are the same or from the same group whereas, in an externally managed REIT, the management is outsourced.

Internally managed REITs are generally preferred over the external ones since the interests lie on common grounds. When the management is outsourced, there are high chances of conflict of interest arising among the stakeholders.

5. Liquidity

Liquidity is not a concern when you invest in REITs as compared to real estate. Depending upon your needs, you can sell a certain number of shares from your REIT portfolio and retain the rest unlike selling a house or an office. In addition to this, you can make the transaction yourself through online REIT platforms without having to worry about paying a handsome commission to the broker like in case of sale and purchase of a physical property.

6. Taxation

REITs are taxed like ordinary income or salary without any long term capital gain benefit. There are also no other benefits associated with dividends earned from REIT investments. This may be a concern for people who already fall under a high tax bracket or will be part of the higher ones after earning these dividends.

The only solace is that unlike corporate dividends, REITs are taxed only once. The taxation in the case of REITs takes place at the shareholder’s side whereas corporate dividends are taxed once at the shareholder level and once at the corporate level.

7. Active and passive REITs

You can invest in REITs in two ways-active investing and passive investing. Active investing refers to stock-picking every single REIT from the lot and building up an exclusive portfolio. Passive investing on the other hand means to simply follow a REIT index fund.

Passive REIT investing does not allow any customization and exclusivity to the investor. Although, passive trading can be beneficial for beginners but as you gain market exposure, it is better to build up a portfolio of your choice to get the best returns.

To sum it up

Even after so many years, investors are still unaware of a lot of features and benefits of investing in such tools. Nevertheless, REITs continue to be a beneficial investment method available to investors. However, it is always better to make an informed investment decision rather than rely on hearsay or be influenced by marketing.

Since REITs are a comparatively newer concept in the investment world, taking professional advice from financial advisors can be an effective way to start investing.