What Are Residential Real Estate Investment Trusts (Reits), And Should I Invest In Them?

February 9, 2023

What Are Residential Reits And How Do They Work?

REITs, or Real Estate Investment Trusts, are companies that own, operate, or finance income-generating residential properties such as apartments or single-family homes. REITs raise their capital by pooling funds from multiple investors to acquire and manage residential properties. They then earn the rental income from their tenants, which is then distributed to investors as dividends. REITs are required by law to distribute at minimum 90% of their taxable income, so this can be a steady source of income for investors. Do note that dividends paid out by REITs are taxable income, and different states may have additional state or local taxes. There are two main categories of REITs: equity REITs and mortgage REITs.

Equity REITs: They make most of their revenue from collecting rental income from the properties they own. This is the most common form of REIT.

Mortgage REITS: They make most of their revenue from mortgage or mortgage-backed securities against the properties they own.

There can be hybrid REITs that mix aspects of equity and mortgage REITs.

To invest in a REIT, investors purchase shares in the company on the stock exchange, similar to buying shares in any other company. The value of the stock varies depending on changes in the real estate market, the economy, and the company’s financial performance. The dividend payout relies on the performance of the company and the amount of money they earn via rental income or financing collections.

What Are The Benefits And Drawbacks Of Investing In A Residential Reit

Investing in a Residential REIT differs from the traditional form of real estate investing where you invest in physical property. Investing in an REIT is more akin to investing in the stock market and comes with its unique benefits and drawbacks.

Benefits Of Investing In A Reit

Low barrier to entry

The initial capital requirement is often much less than investing in a property, and as such, it is also easier to find financing options if needed. Finding a REIT to invest in is as easy as browsing the stock market (if they are a listed company) or finding their details online (if they are unlisted or private). This low entry barrier makes them available to non-real estate investors who want to diversify their portfolios.

Diversification

Speaking of diverse portfolios, investing in a REIT is a quick and relatively affordable way to diversify their portfolio. When investing in the REIT, investors invest in all of the residential properties the REIT owns, reducing their overall portfolio risk.

Passive income

As REITs are required to distribute at least 90% of their taxable income by law, the following dividends are a quick and easy way for investors to earn a passive income without the headache of managing and maintaining real estate.

Easier exits

If needed, it is much easier for investors to liquidate their holdings as it only requires selling the REIT shares. Compared to marketing and finding a buyer for physical property, this is a much quicker and more convenient way to dispose of their assets.

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Drawbacks Of Investing In A Reit

Lack of control

While one benefit of REITs is that the investor does not have to be actively involved in their investments, the flip side is the lack of control. Investors have limited control over the properties and how they are managed.

Market conditions

As with other investments, REITs are sensitive to changes in the real estate market and overall economy, with downturns impacting the value of the shares. As residential real estate can be cyclical, it tends to bounce back fairly quickly after a downturn; however, investors must be ready to bear the risk of this volatility.

Passive income

Dividend payout income is taxable as ordinary income, which may result in higher tax liability than other real estate investment types for investors. Always ensure you understand the tax implications in your investment before you proceed with REIT investments, as taxation is easily overlooked when calculating expected returns.

Conclusion

Investing in REITs can be a relatively easy way to get started in real estate investing, with lower upfront capital requirements. The diversification inherent in REITs allows for lower risk, and the potential for passive income makes these investment vehicles attractive to veteran and beginner real estate investors alike. Consider this as part of your options while your evaluating your next real estate investment. Should you decide to proceed, you may want to secure funding to allow you to get started without dipping into your savings. Contact our team at RE Investor News to enable our specialists to match you with credible lenders aligned with your investment goals.