What are REITs?

REITs Real Estate Investment Trusts Pros and Cons

In the past several months, I have fielded calls from a few different clients that have heard, and become interested in, investing in Real Estate Investment Trusts (REITs for short). A REIT is a form of real estate investment designed to reduce or eliminate tax while simultaneously providing returns on real estate. REIT’s can either be publicly registered and non-traded (does not trade on a securities exchange) or it can be publicly traded on an exchange. (There is a third-type – the Private Placement REIT – that we are not going to address today. In either case, the IRS require the REIT to return at least 90% of the taxable income to shareholders. There are pros and cons to investing in a REIT. While this is provides just a couple of areas of concern with REITs, my hope is that if you’re interested in a REIT, you will ask additional questions before jumping in.

As previously noted, the REIT is required by law to pay out at least 90% of their net income.

PRO: Cash flow can often times be attractive to investors. By being required to disperse 90% of their net income, REITs have a higher average dividend that other stocks. According to REIT advocate Nareit, (listed) REITs were yielding 4.3% in February 2019 compared to 2.04% for the S&P 500. For income hungry investors, that yield difference can be very appealling.

CON: The government requiring the payment of 90% of the net income can act like a double-edged sword. Requiring such a high payout of income can hamstring a REITs future growth opportunities. In order to continue growing, many REITs find it necessary to issue debt to grow. While this can indeed spur growth of the REIT, it can also become an issue for the REIT. Repayment of the debt (as well as the dividend to shareholders) can become a major issue if income falls.

Purchases and Sales of REITs

PRO: When dealing with a publicly traded REIT, a REIT mutual fund or a REIT index fund/ETF, the ability to purchase or sell the shares are pretty straightforward. While some REIT’s, REIT mutual funds and REIT index funds/ETFs are illiquid and pose additional trading risks, many have a very liquid market to allow for an investor to easily invest or divest their holdings. The cost of buying or selling these publicly traded REIT investments are similar to other stock and mutual fund fees.

CON: As I just noted above, not all REITs enjoy a fully-liquid marketplace. There are some publicly traded REIT investments that lack liquidity (or volume). These can pose a hazard for investors as, if there are not enough buyers/sellers, it can have a dramatic effect on the price of the REIT. In addition, not all REITs are publicly traded. Many REITs enjoy “non-traded” status. These REITs may have the ability to “sell” the shares back at either a pre-determined or a price to be named later. Many of the non-traded REITs will have only certain times throughout the year that shares can be redeemed. Additionally, front-end charges for the non-traded REITs can be as high as 15% of the purchase price. There can also be high fees for any early remption of the REIT.

Due Diligence

While there are many, many other variables to look at when deciding whether or not to invest in a particular REIT. In fact, FINRA has released an investor’s alert and the SEC has released a bulletin that I would highly encourage you to review prior to purchasing a REIT. (FINRA’s Alert/SEC’s Bulletin). Much like any other investment, it’s important that you have a good understanding of the risk and not just the potential reward.