What Are Real Estate Investment Trusts (REITs) ? A Beginner's Guide to REITs

Real Estate Investment Trusts (REITs) provide investors an efficient way to access commercial property income and growth without directly owning or managing buildings. By law, these companies are structured to acquire, own, and operate income-producing real estate, distributing most of their profits as dividends. Understanding the basics, benefits, risks, and investment process is essential for anyone considering REITs.​

What Are REITs?

A REIT is typically a company that owns and operates income-generating real estate such as office buildings, apartments, shopping malls, hotels, and warehouses. Unlike real estate developers, REITs generally acquire and manage properties to generate ongoing rental income instead of seeking fast resale and capital gains. Investors can buy shares in a REIT, pooling their capital for exposure to large-scale properties that would otherwise be out of reach for individual buyers.​

How Do REITs Work?

REITs gather funds from many investors and purchase or finance commercial real estate. Revenue comes primarily from rents or mortgage interest payments. Management teams take charge of acquiring, leasing, and maintaining properties. This removes the operational and financial burden from individual investors.​

Types of REITs:

• • Publicly traded REITs: Listed on major stock exchanges, offering daily liquidity and transparent pricing.
  • Non-traded REITs: Registered with regulators but not exchange-traded, making them less liquid and sometimes less transparent.​

REIT investors earn returns in two ways: regular dividend payments (which are often higher than those from other equities due to mandatory payout requirements) and long-term capital appreciation if property values rise or the REIT performs well.​

Benefits of Investing in REITs

One of the most attractive features of REITs is their consistent income stream. Most REITs are required to distribute at least 90% of their taxable income as dividends, which ensures regular and reliable cash flow for investors. This arrangement turns REITs into income-generating vehicles, often preferred by those seeking yield and steady returns.​

Portfolio diversification is another key benefit. Real estate tends to react differently to market forces than stocks and bonds, so combining REITs with traditional assets can reduce overall risk and stabilise volatility. As REITs own a range of property types, from office buildings to apartment complexes, investors achieve greater exposure to sectors typically out of reach for individuals.​

Professional management is integral to REITs. These companies use skilled teams to research, acquire, lease, and maintain property, as well as manage regulatory reporting, so investors don’t have to take on the cumbersome responsibilities of property ownership.​

Most importantly, REITs democratise commercial property investment. By pooling money from many shareholders, REITs enable small investors to own parts of large-scale real estate portfolios such as shopping centres, industrial parks, and hotels, which are generally inaccessible to individual buyers or small firms.

Risks and Considerations

While publicly traded REITs offer daily liquidity, non-traded REITs can be difficult to sell and may tie up invested funds for years. Lack of liquidity is a notable drawback for anyone needing quick access to cash. Furthermore, non-traded REITs suffer from valuation opacity, as their share values aren’t updated daily through market pricing, sometimes delaying true value assessments for months or years.​

There is also a risk in how some non-traded REITs pay dividends; rather than earnings, they might use new investor funds or debt, potentially leading to erosion of the principal and a long-term decline in value. External management, often used in non-traded REITs, can also present conflicts of interest if compensation is tied more to acquisition volume than prudent stewardship of shareholder capital.​

Fee structures are another crucial concern. Non-traded REITs typically charge substantial upfront commissions, often in the 9-10% range, that immediately lower the value of an investor’s holding.

How to Invest in REITs

Publicly traded REITs: Easily bought or sold through a standard brokerage account, using a ticker symbol (just like a stock).​

Non-traded REITs: Typically sold through financial advisors, but with greater risks relating to liquidity and fees.

REIT mutual funds and ETFs: Bundle many different REITs together, offering built-in diversification for a single purchase.​

Understand that most REIT dividends are taxed as ordinary income, not at the preferred rates on qualified corporate dividends, so consulting a tax professional before investing is sensible.​

Key Takeaway

By structuring their business to maximise dividend payouts and professionalise property management, REITs have democratised real estate investment. Yet, like all investments, they carry risks, especially around liquidity and management incentives. For those seeking reliable income and portfolio diversification, without the hassles of direct property ownership, REITs can be a smart, accessible option as long as one understands the structure and fees involved.

For further information read How Do REITs Make Money?