Updated: Jul 21
Real estate is…
“Real estate is a real asset.”
We’ve all heard this adage, but perhaps the better saying is that real estate is personal. After all, each of us interacts with real estate daily in our homes, jobs, and off-the-clock activities.
For some, real estate is an asset class that they want to be hands-on with, buying various properties and managing them. Meanwhile, others have no desire to interact with real estate (as an investment) and instead take the stock and bond approach to have no direct interaction with the asset's daily management. And there are various levels of engagement by investors between these two spectrums.
Unlike last week's post, which discussed a very time-intensive real estate transaction (1031-Exchanges), this week, we will switch over to a much more passive type of real estate transaction: buying and selling REITs.
What is a REIT
REITs are known formally as Real Estate Investment Trusts. These investments are a unique asset class that behaves similarly to stocks yet are notably different.
REITs are individual companies specializing in investable real estate on a grander scale. (A subset of REITs exist that invest in mortgages, but they are not the focus for today)
These specialized companies buy developed or undeveloped properties and turn them into cash-flowing businesses through rental income generated by their residential, business, and retail tenants. They also can create profits (and losses) when they sell properties that they previously acquired.
Similar to real estate investing at the individual level, REITs secure loans to purchase properties. These loans allow them to leverage a larger pool of funding to acquire more properties and, hopefully, greater profits.
However, unlike individuals who invest in real estate, REITs are run by management teams that can provide their operations with greater skill and experience.
REITs receive special tax treatment and are tax-exempt at the corporate level, unlike traditional companies and stocks. Thus, they avoid double taxation!
To qualify for the special tax treatment, REITs must invest and derive their income primarily from real estate and distribute 90% of income to shareholders. Such distributions are known as dividends.
Once investors receive their dividends, they pay personal income taxes on the monies. Unlike ordinary stocks, which receive long-term capital gains tax status, REIT dividends qualify as regular income. Notably, though, they receive a 20% tax deduction on personal tax returns due to the Tax Cuts and Jobs Act of 2017.
Traditional real estate investing can be very profitable. Still, buying a selling a property can be an arduous and prolonged process, plus heavily cash-intensive.
REITs differ, though.
When shopping for a REIT, investors can choose to buy exchange-traded, non-traded, and private placement REITs.
With exchange-traded REITs, investors can buy and sell REITs like stocks and ETFs during regular market hours Monday through Friday. Thus, they are highly liquid.
Further, exchange-traded REITs trade as individual shares, which can range from a few dollars to hundred each - both of which are dramatically cheaper than single properties.
Non-traded and private placement REITs are available too but are not as liquid. Further, they can have purchasing restrictions/qualifications.
What recipe is your REIT?
Contrastingly to traditional real estate, REITs generally are diversified in that they own multiple properties that can be in one area or spread across the globe.
Additionally, REITs can specialize in an individual real estate sector, such as residential properties, or they can invest in various sectors.
Thus, REITs have various recipes that you can tailor to your specific tastes while lowering your overall risk.
Which REIT is right for you?
REITs come in various sizes, types, and formats, so selecting which one is right for you could be tricky. For those looking for broad exposure to real estate, a REIT index fund could be a great fit. However, for those looking for active management or a specialized strategy, other REIT funds or shares could be a better fit. If you need help selecting the right REIT for you, we are here to help.
We are hosting a dinner this upcoming Monday night in Minnetonka! If interested, please call us to RSVP at 952) 933-8489.