Few things are more lucrative than a well-placed real estate investment, but the costs of owning property can be too great for individual buyers to handle. Luckily for small-scale investors, there is another option for breaking into real estate, and it doesn’t take paying an arm and a leg. Real estate investment trusts, or REITs, are companies that own and operate a portfolio containing multiple types of commercial real estate. Much like conventional stocks, REITs are publicly traded, and shares can be purchased by anyone.
REITs came about in 1960, when Congress passed a law enabling individual investors to buy into diverse portfolios of large-scale commercial real estate. Certain REITs specialize in a particular area of real estate, while others focus on property in a particular location. Their liquidity means REIT securities can be traded with ease; as such, investing in an REIT generally presents less risk than buying singular properties. Many REITs offer shares for the relatively low cost of $500 to $2,500.
To be designated an REIT, a corporation has to to pay out at least 90% of its annual taxable income as shareholder dividends, although the majority distribute 100%. As such, REITs are considered “pass through entities,” which exempts them from paying corporate income taxes (federal and state). Instead, the responsibility for paying taxes falls upon investors. Acquiring REIT status also requires fulfilling certain conditions relating to a company’s scale and income sources, which the SEC lays out here.
Since the overwhelming majority of their income must be given out to investors as dividends, REITs look to external sources of funding for capital. Initial public offerings (IPOs) are common practice for REITs–just like typical stocks–except rather than purchasing stock in a singular organization, REIT buyers obtain a portion of a real estate portfolio.
REITs generate earnings by renting, leasing, buying and selling property. Decisions related to asset management are made by an REIT’s board of directors, which is usually composed of real estate experts known for their standout performance in the field. Director responsibilities include determining an REIT’s investments, and recruiting management teams to oversee everyday operations. REIT dividends are paid at regular intervals and split equally among shareholders.
A vast amount of REITs are traded on the public market, which makes them valuable for balancing and diversifying investor portfolios. Many equity REITs’ revenue streams are relatively stable. Also, REITs that generate income from rent are less susceptible to losing value from inflation, as rental costs increase with the cost of life. In general, REITs present investors the possibility of a consistent dividend income, and long-term capital gains as a result of share price appreciation.