Real Estate Investment Trusts (REITs)

A real estate investment trust (REIT) is an investment vehicle that allows investors to invest in income-producing real estate. REITs may own a wide range of real estate assets such as apartments, offices, commercial buildings, warehouses, etc. REITs let investors pool their money with other investors to invest in real estate without owning real estate assets individually. Instead, an investor owns shares in a REIT, and in doing so, they add the individual real estate assets owned by the REIT to the investor’s portfolio. Among other things, REITs are attractive to income-seeking investors for their regular dividend payments and higher-than-average yields. REITs may also provide an investor with diversification in their portfolio. But even with these apparent benefits, investors should understand the inherent risks of REITs and how to manage them.

First, it is key for investors to recognize the type of REIT in which they choose to invest. Different types of REITs hold different kinds of assets within the broad category of “real estate.”

• Equity REITs: An equity REIT owns and operates income-generating properties. They generally focus on one type of income-producing property (i.e., shopping malls, apartment buildings, office buildings, etc.). The rents paid by tenants generate the REIT’s revenue. Revenue may also be derived from real estate sales. Equity REITs are the most common type of REIT.
• Mortgage REITs: A mortgage REIT or mREIT invests in mortgages, mortgage-backed securities, and other real estate loans. The REIT’s revenue is generated by interest income. Mortgage REITs use more borrowed capital and are more leveraged than equity REITs. They also have exposure to interest rate hikes and higher credit risks. They use derivatives and other hedging strategies to manage them.
• Hybrid REITs: A hybrid REIT combines the investment techniques of both equity REITs and mortgage REITs to generate revenue. In other words, hybrid REITs own properties that produce rental income and mortgage loans that pay interest income.

Next, investors should consider whether the REIT is publicly traded, not publicly traded, or private.

An exchange-traded REIT is a publicly-traded REIT registered with the Securities and Exchange Commission (SEC) and must meet all their regulatory requirements, including the filing of regular financial reports with the SEC.

Publicly traded REIT shares are listed and traded on major exchanges. They are typically liquid investments that investors can buy and sell as they would any other stock on their portfolio. As a result, investors can determine the REIT’s real share value based on the publicly available market prices.

Investors in exchange-traded REIT are generally not subject to penalties or limitations in selling their REIT shares.

A non-traded REIT is registered with the SEC and must meet all their regulatory requirements but is not traded on a stock exchange.

Because they are not traded on stock exchanges, they lack liquidity, and investors cannot sell REIT shares on the open market. Non-traded REITs offer share redemption programs; however, they often come with limitations such as minimum holding periods, restrictions on the number of shares available for early redemption, and high fees and penalties. Investors selling through a share redemption program will generally sell for a price lower than the purchase price.

Non-traded REITs have higher investment requirements and often charge investors 10-15% of the investment in broker-dealer commissions and other upfront offering costs. Non-traded REITs may include additional costs such as management fees, ongoing acquisition, and back-end fees. While investors may be drawn to the high dividend yields of non-traded REITs, they should consider the product’s total returns and their own financial situation.

Unlike publicly-traded REITs, investors do not have access to independent information to verify the real share value or measure the performance of non-traded REITs.

A private REIT is a private placement REIT exempt from registration with the SEC pursuant to Reg D of the Securities Act of 1933. Shares of a private REIT are not traded on stock exchanges.

Investing in private REITs is limited to institutional investors, such as pension funds and accredited investors. Under Reg D rules, this may include individuals with at least a $1 million net worth, individuals with income exceeding $200,000, or joint income with a spousal equivalent of $300,000. Accredited investors may also include family offices with at least $5 million of assets under management, family office clients, limited liability companies with $5 million in assets, SEC- and state-registered investment advisers (RIAs), exempt reporting advisers, rural business investment companies (RBICs), and any entity that owns investments in excess of $5 million.

Investors who can meet these net worth, income, or professional knowledge and experience requirements may invest in private REITs; however, they are not for everyone. Private REITs lack the baseline transparency and protections afforded to investors by the SEC’s disclosure requirements and have high fees and broker-dealer commissions. They also have high investment requirements, and depending on the issuer, may not offer share redemption programs.