A real estate investment trust (REIT) is undoubtedly an attractive option for many investors. But like most investment types, it has pros and cons you should be aware of.
Basically, REITs are a pool of funds invested in real estate assets. They’re like mutual funds, but rather than investing in some listed companies, you’ll invest in income-generating real estate assets. So if you’re planning to invest in real estate and prefer something that has the same tradability feature as stocks, REITs are an excellent investment option for you.
At present, there are many platforms out there you can use for REIT investing, such as DiversyFund. However, before you decide to invest through it, make sure to check out some DiversyFund reviews so you’ll know exactly what you’ll be signing up for.
Regardless of the platform you’ll go for, keep reading to discover the pros and cons of REITs to determine whether or not they’re suitable for you.
1. Diversify Your Investment Portfolio
Once you invest in REITs, you’ll have the opportunity to diversify your investment portfolio. Instead of investing only in bonds and stocks, you can enjoy the high returns of real estate without the risk and volatility of stocks. Also, real estate enjoys correlation with stocks, which protects your investment from market fluctuations.
You can also quickly diversify in the real estate market by owning interests in various properties across several sectors as an investor. Investors may take a small amount of cash and spread it across various property types, from industrial warehouses to commercial properties to apartment complexes. In most cases, such funds include big properties like hotels or office buildings that some investors can't access.
In addition, REITs allow you to diversify geographically. They let you purchase fractional ownership of properties in many states, cities, and countries. Overseas investors who are often restricted from owning properties in another country can acquire ownership interest via REITs.
2. High Dividend Yields
Since a REIT must pay at least 90% of taxable income to shareholders, it tends to have above-average dividend yields. It isn’t uncommon for REITs to have a 5% or more safe dividend yield while the average stock yields less than 2%. With that said, there’s no doubt that investing in REITs can be an excellent choice for people who aim to reinvest their dividends or need income and let their gains increase over time.
3. Good Return Potential
One of the best things about investing in REITs is that you may enjoy a good return potential. This is especially true if the value of their underlying assets increases. Real estate values tend to increase in the long run, and REITs may use some strategies to create additional value. They could develop properties from scratch or sell some valuable properties to make the most of their capital.
Combined with high dividends, REITs are great total return investments. In fact, other REITs can generate total returns that beat the market for years.
Selling and buying properties may take a while. REITs, on the contrary, are an excellent liquid investment. You can sell or buy a REIT whenever you like with just a click of a button. If you need money from your investment, you can easily free up your cash.
5. Access To Commercial Real Estate
If you want to invest in commercial real estate, another advantage of REITs is that they allow you to put your money to work in such assets. Often, many people can’t purchase a class A office building by themselves. With REITs, you can own a piece of hundreds of data centers, apartment complexes, and even shopping malls.
1. Sensitive To Interest Rates
Several factors influence most investments, but in terms of REITs, they can be very sensitive to changes in interest rates. Rising interest rates may spell trouble for the price of REITs. Basically, the value of the trust is tied to the Treasury yield, so when the yield increases, the value of the REIT will likely decrease.
2. Taxes On Dividends
Although you don’t need to worry about paying a corporate tax with REITs, one of the cons you should know is that the dividends are often taxed at a higher rate, unlike some investments.
Usually, dividends are taxed at the same rate as a long-term capital gain, which is lower than the rates at which regular income is taxed. But the dividends paid from a REIT don’t qualify for the capital gains rate. Commonly, they’re taxed as one’s ordinary income.
3. Trends Influence REITs
When compared to some types of investments, a REIT may fall prey to the risks specifically associated with the property. For instance, if someone invests in REITs with a portfolio of yogurt shops in strip malls, they could see their investments take a hit if the malls or yogurt in general falls out of trend.
While investments fall prey to trends, REITs may be influenced by other trends specific to the property type or location, which can be more challenging for investors to notice.
4. Potential High Fees And Risks
Before investing in REITs, do your research and consider various factors in the real estate market, such as interest rates, changing tax laws, geography, debt, and property values. The reason behind this is that other REITs may charge high transaction and management fees, resulting in low payouts for shareholders.
Typically, they hide those fees in the fine print. Therefore, don’t hesitate to spend more time reading the fine print carefully to learn more about acquisition fees and property management, among other matters.
5. Work Best As A Long-Term Investment Only
Real estate investing with REITs is ideal for long-term investment purposes. Other than interest rate fluctuations, there are many factors that impact the prices of REITs over a short period. Never put any money in REITs if you’re going to need it within the next few years because a longer time horizon is better for such options. If you prefer a short-term investment, a REIT might not work for you.
For many investors, the pros of investing in REITs outweigh the cons. However, it’s essential to know what you’re getting into before you add any kind of investment to your portfolio. The above advantages and disadvantages will help you make a well-informed decision on whether or not to invest in REITs.