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Understanding Real Estate Investment Trusts (REITs)

REIT and REITs inside of a self-directed IRA account
REITs inside your self-directed IRA

Get a better understanding of what REITs are and how you can incorporate them into your trading or investing strategy.

What are REITs?

A Real Estate Investment Trust (REIT) is a security that trades like a stock on the major exchanges and owns—and in most cases operates—income-producing real estate or related assets. Many REITs are registered with the SEC and are publicly traded on a stock exchange. These are known as publicly traded REITs. Others may be registered with the SEC but are not publicly traded. REITs receive special tax considerations and typically offer investors high dividend yields, as well as a liquid method of investing in real estate.

REITs, which are structured as a corporation, are not typically taxed at the entity level, which allows investors to avoid double taxation on dividends. REITs must invest in real assets and derive the majority of their income from real estate activities, including rents from properties and interest from mortgages. The REIT must also pay out 90% of its annual taxable income in dividends. Due to this structure, they typically pay out a higher rate of dividends than equities or many fixed income investments. Dividends received from REIT holdings are taxed as regular income.

Benefits and risks of REITs:

Potential for higher yield

REITs typically pay higher dividends than common equities. REITs are able to generate higher yields due in part to the favorable tax structure. These trusts own cash-generating real estate properties.

Accessibility

REITs are typically listed on a national exchange and provide investors considerable liquidity. These securities invest in a portfolio of commercial real estate assets that are not typically available to retail investors.

Diversification

REITs can provide diversification benefits because they tend to follow the real estate cycle, which typically lasts a decade or more, whereas bond- and stock-market cycles typically last an average of roughly 5.75 years.

Inflation hedging

REITs can serve as an effective hedge against rising inflation rates. In particular, REITs with commercial holdings frequently have agreements that allow them to raise rents in tandem with inflation.

Risks:

Real estate risk

REITs closely follow the overall real estate market and are subject to much of the same risks, including fluctuations in property value, leasing occupancy, and geographic demand.

Interest rate risk

Real estate is typically very sensitive to changes in interest rates, which can affect property values and occupancy demand.

Occupancy rate risk

In order to maintain the expected payouts, REITs must maintain certain occupancy levels. This closely ties in with the amount of rent that these properties are able to command. Lower rents and occupancy rates may negatively impact REITs.

Geographic risk

REITs can have a narrow geographic focus where the majority of the property is located in a particular area or region.

Business risk

REITs can be highly susceptible to the underlying business or industry that leases the properties.