What are the pros and cons of REITs?
Real estate investment trusts reduce the barrier to entry for investors in the real estate market and provide liquidity, regular income and other perks. However, you'll be exposed to risks that aren't inherent in the stock market and dividends are subject to ordinary income tax.
Cons of Investing in a Private REIT
Additionally, they may lack the liquidity of publicly traded REITs, making it more challenging to sell your investment if needed. Moreover, private REITs are generally riskier investments compared to their publicly traded counterparts.
There are three key reasons to invest in listed REITs right now, starting with the fact that REITs have outperformed stocks and bonds when yields and growth move lower. Demand is healthy while supply is constrained, and REIT valuations relative to the broader equity market are meaningfully below the historical median.
“To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90% of its taxable income to shareholders annually in the form of dividends.”
When investing only in REITs, individuals incur more risk than when they are part of a diversified portfolio. REITs can be sensitive to interest rates and may not be as tax-friendly as other investments.
REITs are also attractive thanks to their market-beating returns. During the past 25 years, REITs have delivered an 11.4% annual return, crushing the S&P 500's 7.6% annualized total return in the same period.
In most cases, REITs utilize a combination of debt and equity to purchase a property. As such, they are more sensitive than other asset classes to changes in interest rates., particularly those that use variable rate debt. When interest rates rise, REITs share prices can be prone to volatility.
Can You Lose Money on a REIT? As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.
Perhaps the biggest advantage of buying REIT shares rather than rental properties is simplicity. REIT investing allows for sharing in value appreciation and rental income without being involved in the hassle of actually buying, managing and selling property. Diversification is another benefit.
While a REIT is still open to public investors, investors may be able to sell their shares back to the REIT. However, this sale usually comes at a discount; leaving only about 70% to 95% of the original value. Once a REIT is closed to the public, REIT companies may not offer early redemptions.
What happens to REITs when interest rates fall?
REITs. When interest rates are falling, dependable, regular income investments become harder to find. This benefits high-quality real estate investment trusts, or REITs. Strictly speaking, REITs are not fixed-income securities; their dividends are not predetermined but are based on income generated from real estate.
Rates boosting REITs
Among the strongest factors shaping the REITs market as we move into 2024 is the likelihood of federal interest rate cuts. If those do materialize, we could see a lot of growth for the sector. According to Sakwa, that scenario holds true if the Federal Reserve cuts rates multiple times.
For Group REITs, the consequences of leaving early apply when the principal company of the group gives notice for the group as a whole to leave the regime within ten years of joining or where an exiting company has been a member of the Group REIT for less than ten years.
“I recommend REITs within a managed portfolio,” Devine said, noting that most investors should limit their REIT exposure to between 2 percent and 5 percent of their overall portfolio. Here again, a financial professional can help you determine what percentage of your portfolio you should allocate toward REITs, if any.
For purposes of the REIT income tests, a non-qualified hedge will produce income that is included in the denominator, but not the numerator. This is generally referred to as “bad” REIT income because it reduces the fraction and makes it more difficult to meet the tests.
Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.
- Dividend Taxes. REIT dividends can be a great source of passive income, but the money you receive is subject to your ordinary income tax rate, which will depend on your tax bracket. ...
- Interest Rate Risk. ...
- Market Volatility.
- You Have Little Control.
- Some Charge High Fees.
Shares peaked at the end of 2021 and have fallen by about half since that point. Higher interest rates have frightened investors. An increase in funding costs hits all REITs and is especially harsh on smaller faster-growing entities like National Storage Affiliates.
Since REITs typically employ heavy leverage to develop and manage properties, high interest rates tend to increase borrowing costs and at the same time slow down property appreciation. That could leave some REITs with less revenue to dish out to shareholders, making them slightly less attractive this year.
| # | Name | M. Cap |
|---|---|---|
| 1 | Prologis 1PLD | $94.48 B |
| 2 | American Tower 2AMT | $80.11 B |
| 3 | Equinix 3EQIX | $67.48 B |
| 4 | Welltower 4WELL | $56.31 B |
Can REITs go out of business?
REIT bankruptcies have indeed been a rarity since the REIT debacle of the mid-1970s, when high leverage and highly speculative real estate investments resulted in numerous REIT failures. Thereafter, REIT managers became far more conservative in their investment and financing practices.
If the REIT fails this ownership test for more than 30 days (31 days if the year has 366 days) in a taxable year of 12 months, it can lose REIT status and cannot elect to be treated as a REIT for five years (IRCĐ°Đ·Đ·Đ°856(a)-(b)). The test is pro-rated for taxable years shorter than 12 months.
The majority of REIT dividends are taxed as ordinary income up to the maximum rate of 37% (returning to 39.6% in 2026), plus a separate 3.8% surtax on investment income. Taxpayers may also generally deduct 20% of the combined qualified business income amount which includes Qualified REIT Dividends through Dec.
REITs have access to capital and are acquiring assets, making it a good time to invest. REITs historically rebound when interest rates pivot and have the potential for rent growth.
Lesson #1: The Dividend Should Be An Afterthought
But here you need to know that the highest-yielding REITs are often the least rewarding over the long run. It may sound counter-intuitive, but lower-yielding REITs have actually been far more rewarding than higher-yielding REITs in most cases.
