A real estate investment trust (REIT) is a security traded on major stock exchanges like a stock that owns — and in most cases manages — income-producing real estate or related assets. Known as mortgage REITs, most REITs finance income-producing real estate by buying or lending mortgages and mortgage-backed securities and earning interest on the investments. One of the main reasons to invest in REITs is that they can acquire real estate—residential, commercial, or retail—without having to directly purchase individual properties.
If you’re looking to make some money from your portfolio, REITs often seem like an attractive way to do it. Investors looking for cash and income growth may consider REITs as a long-term solution. Investing in certain types of REITs, such as hotel real estate, is not the best choice during an economic downturn.
Instead, the REIT buys and develops real estate primarily to manage it as part of its own REIT investment portfolio. Unlike other real estate companies that build properties with the intent to sell them, the main purpose of a REIT is to develop, manage and include real estate in their investment portfolios. Typically, a REIT rents out the property it owns and collects rent as its main source of income.
There are several factors that investors should consider before buying a Real Estate Investment Trust. Some REITs offer higher risks for larger potential gains, while others are more suitable for those who want to make money over a longer period. Here’s how to select the best REIT for your portfolio. It might surprise you to learn that some REITs offer less risk than others. In addition, you can also choose to invest in Sector-focused REITs.
Interest rate sensitivity
The interest rate sensitivity of real estate investment trusts is dependent on the level of interest rates and the sector in which they operate. Residential and retail REITs are less sensitive to interest rate changes than are industrial and specialty REITs. However, interest rate sensitivity also varies in other sectors and geographic locations. This asymmetry in interest rate sensitivity could affect investment decisions in these sectors. The researchers acknowledge the contribution of anonymous referees and their comments.
The sensitivity of REITs to interest rates is measured by daily excess returns. For example, if interest rates rise by one percent, triple-net lease REITs increase their yield by about 1.5%. In contrast, hotel REITs experience a negative interest rate beta. Thus, investors should carefully research REITs before investing. In addition to looking at interest rate sensitivity, investors should also consider the performance of the REITs, dividend payouts, and debt levels.
REITs have higher leverage and interest coverage than before the financial crisis. This means they can still deliver dividend growth, but are less sensitive to rising interest rates than equity REITs. According to Robert R. Johnson, a member of the Fed Policy Investment Research Group in Virginia, equity REITs returned 9.8% per year during the rising interest rates while mortgage REITs lost 4.1% per year. This means that the best REITs can deliver consistent dividend growth, even in a low interest environment.
As long as the economic situation remains stable, REITs tend to rise in price. The longer interest rates are, the higher they will be. When the economy grows, investors purchase REITs because they expect higher returns. However, as the Fed tightens money, the REIT industry has become a bond alternative. Thus, REITs’ interest rate sensitivity reflects the duration of the contracts. For example, a two-year Treasury will decrease by one percent for every rise in interest rates while a 30-year Treasury will drop by thirty-one percent.
Taxes
Listed below are the basic rules governing taxes on real estate investment trusts. REITs are taxable corporations and issue 1099-DIV forms to investors. According to TurboTax, a leading tax software company, each box in the form has specific implications for your taxes. Box 1a reports total ordinary dividends, while box 1b reports qualified dividends. Box 2a reports capital gains. The following information will help you determine what you owe in taxes on REITs.
The primary difference between an REIT and a taxable company is the amount of tax deferral. If you invest in a REIT that pays dividends, you can defer paying tax on these distributions until you sell the shares of stock or REIT units. If you do sell the shares later, you may have to pay capital gains tax. But this tax relief can also help reduce your overall capital gains tax bill.
The new tax law affects REITs in several ways. The changes to the tax rate are likely to impact the way these companies report their income, deductions, and capital losses. The Tax Cuts and Jobs Act, which was passed into law in December 2017, also affects REITs. The tax cut primarily affects REITs that invest in residential rental properties. It is unclear how the government will target taxes on REITs.
The bulk of REIT distributions consist of ordinary income. However, in certain cases, REITs distribute capital gains. These distributions are taxed at a lower rate than ordinary income and are subject to preferential rates. When REITs distribute profits, the investors receive a “return of capital,” which reduces their cost basis. This deferred tax payment is not taxable until the investor sells the shares.
Dividends
Dividends from Real Estate Investment Trusts (REITs) are a great way to increase your portfolio’s return on investment. As a real estate investor, you’ve probably heard about dividend growth. A REIT has a high dividend yield and typically pays more dividends than stocks do. In fact, the average REIT’s dividend payout is more than double the average S&P 500 dividend payout.
One of the most important things to look for in a REIT is dividend safety. When a REIT cuts dividends, the shareholders are permanently wiped out, and the shares crash. This is because REITs are structured for tax purposes and traditional measures of dividend safety are not applicable to them. Dividends are generally treated as ordinary income, but there are some exceptions. For tax purposes, you should focus on dividend safety rather than growth.
The Federal Reserve is slowly ending its ultra-loose monetary policy, but the REIT industry is far from crashing. A rising 10-year Treasury bond yield could send share prices lower, but this doesn’t mean it will kill the sector. In fact, REITs have thrived under interest rates as high as 21 percent. As long as they have good management teams, you’ll be fine. But be sure to invest responsibly and be financially prepared.
The dividends that REITs pay are usually at least 90% of their taxable income. While that seems unsustainable over time, the reality is that most REITs earn much more than their taxable income, and the dividends are taxed as regular income. The depreciation of real estate is one such tax deduction. You can easily earn a hundred-dollar profit if you sell your shares. Just remember to watch the share price carefully to ensure you make a profit.
Sector-focused REITs
REITs that focus on a particular sector include health care REITs, which own and rent out medical office buildings, hospitals and senior living facilities. Another type of REIT, known as a “specialty REIT,” owns storage facilities and collects rent from customers. These REITs also own portions of their real estate for other purposes such as manufacturing wood products. Finally, there are infrastructure REITs, which own and lease real estate such as energy pipelines and telecommunications towers.
REITs specializing in a single sector are usually much more volatile than other types of debt. Some REITs are incredibly specialized in their area of focus, while others are more generic. Health care REITs might invest in hospitals, while office REITs would focus on skyscrapers and office buildings. Retail real estate REITs may focus on storefronts, multi-family apartment buildings, or other types of income-generating properties.
These REITs can diversify your investment portfolio by offering lower minimums and low risks. Many investors find this approach to be advantageous because it makes investing in real estate much more accessible for investors of all experience levels. The benefits of REITs are numerous. REITs are an excellent way to invest in real estate without putting up a large initial amount of money or managing a single property yourself. They are also a great way to add property to your investment portfolio without the hassles and costs of ownership.
In the fourth quarter of 2012, the average occupancy rate for the retail S-REITs rose to 99.1%, while the “weighted average lease to expiry” was still 3.4 years. A strong operating performance and a few acquisitions helped the S-REITs in this sub-sector achieve impressive year-over-year net profit growth. They continued to lease properties to sustain the sub-sector’s growth.
Diversification
REITs are pools of capital that invest in a variety of real estate assets. A REIT may own direct real estate properties, loans to real estate developers, or a combination of both. REITs are divided into categories based on their focus on different real estate asset classes. A REIT may be a public or private company, and investors can select the type that best meets their needs and financial goals.
Some diversified REITs concentrate on single-tenant net lease properties, a form of real estate that makes the tenants responsible for all maintenance, building insurance, and real estate taxes. These REITs can collect consistent rental income from single-tenant properties while minimizing their risk. Other diversified REITs own properties with variable rental income, such as multi-tenant properties and those operated by third parties. These types of REITs may experience rapid declines in occupancy or rates during a recession.
REITs also offer passive income from dividends. The income received from these dividends may be more important than short-term share-price volatility. Furthermore, REITs are different from both stocks and bonds, which means that holding REITs can diversify stock holdings and broaden asset allocation. Diversification and asset allocation are two investment strategies used to manage investment risk. Diversification involves buying and selling properties, which may tie up cash flow.
In order to benefit from the diversification benefits of real estate investment trusts, investors should pay attention to their underlying investments. Listed REITs have low volatility and lower fees than private REITs. However, private REITs may have higher account minimums and require higher fees. As a result, private REITs are generally only available to high-net-worth individuals. Diversification can be beneficial to both individual and institutional investors.
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