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Real Estate Investment Trusts (REITs) Encourage Real Estate Investing

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Real estate investment trusts, known as REITs, facilitate investors’ exposure to different types of real estate investments. By purchasing shares in a REIT, investors can gain investment income generated by certain properties.

Historically, REITs have delivered competitive returns to investors. They’re popular in the United States; investors have deposited about $1.6 trillion in them. They are also popular in countries outside the United States. Over 40 countries today have REITs, a number that continues to grow.

History of REITs

Congress created the RTIS in the 1960s. Structured as pass-through entities, the goal was to encourage broader participation in real estate investing.

As a result of their legal structure, REITs must pass on 90% of their taxable income to shareholders as unqualified dividends. REITS usually pay these out in monthly or quarterly installments. The ordinary income tax rate applies to unqualified dividends, rather than the long-term capital gains tax rate that applies to most regular corporate dividends.

Similar to an index fund or exchange-traded fund (ETF), investors must pay the REIT a small management fee. This fee is typically 1-2% of the total equity investment.

REIT Categories

REITs fall into three main categories: equity, mortgage, and hybrid. As the name suggests, hybrids are real estate companies that deploy a combination of mortgage and equity REIT strategies.

Equity REITs are real estate companies that own income-producing properties and derive income from rents, property sales, and dividends. Most REITs operate as equity REITs. They might invest in properties like apartments, office buildings, and shopping centers.

Mortgage REITs purchase or originate mortgages and mortgage-backed securities in order to provide financing for income-producing real estate. A large portion of the income earned by them comes from the interest collected on the mortgages.

Any given REIT can have investments that cover a broad array of property types. Some examples of property types include retail, self-storage, office buildings, hotels, data centers, apartments, warehouses, shopping centers, and timberland.

Self-Storage REITs
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One real estate sector that has been taking off during the pandemic is self-storage. With the extended lockdown, Americans have been clearing out space to make room for gym equipment and home offices. Others have temporarily relocated to work remotely from different locations. Since February 2020, self-storage shares in the FTSE Nareit All Equity REITs Index have generated an 84% return.

Most REITs trade publicly on major stock exchanges. A small number of them are “non-traded” because they are not listed on public exchanges. Non-traded REITs are usually set up to give investors access to inaccessible real estate investments while taking advantage of favorable tax attributes.

REIT Performance

Several indexes track REIT performance. In the United States, some of the most prominent include MSCI US REIT Index, Morningstar REIT Index, S&P United States REIT, and the FTSE Nareit All Equity REITs Index.

According to data through November 10, 2021, the Morningstar U.S. REIT Index posted a 33.3% return this year. In comparison, the S&P 500 Index, which tracks the performance of major U.S. stocks, posted a 27.2% return for the year.

Just like with any type of investment, there can be wide variation in the yield of any given REIT. “It comes down to the underlying business,” stated Morningstar analyst Kevin Brown. “There are a lot of different sectors and they operate on their own fundamentals.”

Generally speaking, investors should consider REITs as steady, longer-term investments. “Both public and non-public REIT investments should be considered long-term, and that could mean different things to different folks, but in general, investors who typically invest in REITs look to hold them for a minimum of three years, and some of them could hold them for 10+ years,” said Sachin Jhangiani, co-founder of Elevate Money.

Investors use three common metrics to evaluate the financial performance of REITs. These include net asset value (NAV), funds from operations (FFO), and adjusted funds from operations (AFFO). The National Association of Real Estate Investment Trusts (NAREIT) has adopted standardized definitions and formulas for many of these terms.

REITs as a Hedge Against Inflation

As inflation continues to skyrocket, REITs are likely to rise in popularity. Real estate is widely regarded as one of the best asset classes to hedge against inflation.

“To the extent people are concerned about inflation, this is one of the best asset classes that can hedge against that,” said Greg Kuhl, a portfolio manager at Janus Henderson who specializes in global property equities. “So there are some things that really work in its favor from that perspective, too.”

Marco Rimassa, the President of CFE Financial in Texas, provided one explanation for the success of the REIT in inflationary environments. “Generally, REITs tend to do well in times of inflation, just because of their ability to increase rents and then pass that income on to shareholders.”

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