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As the name suggests, hybrid REITs use a mix of investing strategies, owning both actual properties and mortgages. These are appealing to generalist investors who can't decide one way or another between equity and mortgage REITs, though hybrid REITs tend to lean one way or another. While REITs usually focus on one of these real estate sectors, some of them do hold multiple types of properties in their portfolios.
Before you can decide whether or not investing in REITs is right for you, it's crucial to understand their advantages and disadvantages. REITs generally return higher-than-average dividend yields and provide some potential for capital appreciation in the long-term. REIT distributions are non-qualified dividends , which means your payout is taxed as ordinary income.
REITs offer portfolio diversification for investors. Liquidity for real estate investments, which are traditionally notoriously illiquid. REITs, themselves, are not diversified. They can lose value if their sector falls. These are the most common REITs, and the ones most individuals should consider. Also known as non-listed REITs, this type is still regulated by the SEC and subject to its reporting requirements, but the companies are not traded on a national stock exchange and are subject to certain investment limits.
Inventors must purchase shares directly from the REIT or a third-party dealer. They can also come with high upfront transaction fees. As such, they are designed for institutional or accredited investors and typically have a much higher minimum investment amount — often, in the five-figure range — and come with higher risk. Offered by investment companies like Vanguard or Fidelity, these vehicles are managed funds that invest the majority of their assets into REIT securities and related derivatives.
REITs offer liquidity in real estate investing, something that seems contradictory. They can be a way to diversify your portfolio while gaining access to steady income and a little long-term capital appreciation. However, while they eliminate many of the customary drawbacks of real estate, REITs also come with downsides. These include a higher tax rate and an inherent sensitivity to both interest-rate risk and market sector risk.
Overall, though, they remain a relatively safe way for individual investors to make a property play. Back to Top A white circle with a black border surrounding a chevron pointing up. It indicates 'click here to go back to the top of the page. Credit Cards Angle down icon An icon in the shape of an angle pointing down.
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Twitter icon A stylized bird with an open mouth, tweeting. Twitter LinkedIn icon The word "in". LinkedIn Fliboard icon A stylized letter F. Total-return potential -- One reason real estate has made so many millionaires is for its high total-return potential. Note: Total return is a stock's dividends combined with growth in its share price.
I briefly mentioned before that the primary motivation for a real estate company to qualify as a REIT is because of a big tax advantage that comes with the status. Here are the specifics. Most companies have their profits effectively taxed twice. When a company earns a profit, it typically has to pay corporate tax. Then, when shareholders receive some of these profits as dividends or sell their stock at a profit, they have to pay tax again. To be sure, there are favorable tax rates for qualified dividends and long-term capital gains , but this still is a double taxation of the same corporate profits.
REITs, on the other hand, are not taxed on the corporate level as long as they pass most of their profits directly to shareholders. Investors need to pay dividend taxes on their income, as well as capital gains taxes when selling REIT shares for a profit, but avoiding corporate taxes can be a big benefit. This allows investors to effectively defer or even avoid taxes on the personal level, as well as on the corporate level.
One potential negative is that REIT dividends are more complicated than those paid by most stocks in terms of their tax structure. Specifically, most dividends paid by U. However, most REIT dividends don't qualify. In fact, REIT dividends are often split up into three different categories -- ordinary income, capital gains, and return of capital -- depending on how the REIT made its money during the tax year.
And all three of these are taxed differently. Ordinary income is taxed at your marginal tax rate tax bracket , and high earners also can be required to pay a 3. However, thanks to the Tax Cuts and Jobs Act, pass-through income , including that from REITs, can be deducted, which effectively lowers the tax rate you'll pay. Return of capital is not taxable, but lowers your cost basis in the stock, which can lead to capital gains taxes when you eventually sell.
Here's a real-world example of how this works. Note: Numbers may not add perfectly, due to rounding. This may sound complicated -- and it is -- but the good news is that your brokerage will keep track of your dividend categories for you. You'll receive a DIV tax form soon after the end of the year, which will contain the tax classification of the dividends you've received. In addition, if you hold your REIT stocks in a retirement account, you won't have to worry about dividend and capital gains taxes.
In a traditional IRA or other tax-deferred account type, you'll just have to pay income tax on your eventual withdrawals from the account. With a Roth IRA or other after-tax account type, you won't have to pay tax at all on qualified withdrawals. Traditional methods of calculating a company's net income, or "earnings," just don't work for REITs.
Specifically, companies are allowed a deduction for depreciation of their properties each year, and this makes REIT income look far lower than it actually is. After all, properties don't actually lose value every year -- in fact, the opposite generally is true. While different REITs have different ways of calculating these metrics, the bottom line is that these are intended to give a company-specific view of a REIT's performance.
Finally, another important metric for real estate investments is capitalization rate , or "cap rate. No discussion of any investment would be complete without mentioning the risks involved, so here are some of the key risks that REIT investors should be aware of. First, REITs tend to be extremely sensitive to changes in market interest rates.
As rates rise, investors expect their "riskier" investments like REITs to pay a premium over what they could get from risk-free investments like Treasury bonds, which puts downward pressure on stock prices. Conversely, in periods of falling market interest rates, REITs tend to rise.
REITs also have property type-specific risks. For example, many key self-storage markets are facing oversupply issues in , so this has put downward pressure on many self-storage REIT stocks. Another example is the pressure put on retail REITs by the recent wave of retail bankruptcies in the U.
Also, keep in mind that a REIT is only as valuable as the properties it owns. If real estate has a major downturn, like it did during the financial crisis, it could make REITs' intrinsic values fall. And finally, there are certainly company-specific risks to consider. For example, if a specific REIT takes on too much debt, it can be a big risk factor for that particular company, even though its properties may be performing just fine. Here are the broad categories of REITs, and notable beginner-friendly examples of each type, which new REIT investors may want to take a closer look at.
Just to name a few examples of prominent residential REITs :. AvalonBay Communities specializes in apartment properties located in high-barrier coastal markets such as New York and San Francisco. American Campus Communities develops and operates student housing properties located on or near major U.
These can focus on a certain type of retail property such as shopping malls, outlet centers, shopping centers, or freestanding properties. Some choose to have a more diverse strategy that includes several different types. It also has a dominant market share in the outlet retail business. Realty Income specializes in net-lease retail properties , which typically means single-tenant properties where the tenant pays for property taxes, insurance, and maintenance expenses.
Welltower is the largest healthcare REIT and primarily invests in senior housing and other senior-specific property types. Physicians Realty Trust invests in medical office buildings, especially those associated with major health systems. HCP is a large healthcare REIT that specializes in three specific property types -- senior housing, medical offices, and life science facilities -- with similar allocations to each one.
In terms of revenue, Public Storage is larger than its next three competitors combined. Life Storage is more of an up-and-comer, and recently rebranded itself from Uncle Bob's Self Storage. Prologis specializes in distribution centers and aims to capitalize on the growth of e-commerce and the need for logistics real estate that comes with it.
Boston Properties is one of the largest owners of Class A top-quality office real estate in the U. Apple Hospitality REIT owns a large portfolio of "select service" hotels, which is a term for the midrange of the hotel market. Major hotel brands in the select service category include Homewood Suites by Hilton and Courtyard by Marriott. Host Hotels and Resorts focuses on high-end hotel properties and is the largest hotel in the market.
Data Center REITs -- A data center is a specialized facility designed to provide secure and reliable space for companies to operate servers and other networking equipment. Data center REITs have become a much larger piece of the market in recent years, thanks to the surge in connected devices worldwide.
Equinix is the largest data center REIT of all and has a geographically diverse revenue stream, with less than half of its revenue coming from the Americas. Hospitality Properties Trust owns a portfolio of more than hotels and about travel centers adjacent to interstate highways.
EPR Properties specializes in three distinct property types -- entertainment, recreation think waterparks and golf attractions , and education. American Tower is a REIT that owns and operates communications towers used by mobile communications providers, cable companies, and more.
As a final point, let's take a closer look at how you may want to go about evaluating a REIT. Does the REIT trade for a reasonable valuation? A price-to-FFO multiple of Is there a margin of safety? Realty Income's net-lease structure helps to ensure high occupancy and low turnover, even in tough economic times. It's also resistant to retail headwinds, as most of its tenants' businesses are resistant to e-commerce and recessions.
Does the REIT carry lots of debt? Is it financially flexible? Is the portfolio diverse? That is, is too much of the revenue dependent on one or a few tenants? Tenants operate in 11 different industries, and the properties are located in all 49 states and Puerto Rico. Does the REIT have a strong dividend-payment record? Not only does Realty Income pay a 4.
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