REIT Fundamentals: Kinds, Returns, and Risks When investors want to increase their portfolio's yield, they frequently use real estate investment trusts (REITs), which are stocks. These investment options provide a simple way to hold a stake in real estate that generates income. Although REITs have the potential for high returns, they are riskier than lower-yielding alternatives like Treasury bonds, like most assets with high returns. Here are some things to think about when determining whether the risks taken to achieve the potential profits of REITs are worthwhile.
How Do REITs Work?
REITs are businesses whose sole aim is to own and manage real estate assets. Some people invest in commercial real estate, like parking lots or office buildings. Some people make investments in homes or apartment complexes. REITs must legally distribute 90% of their profits to shareholders in the form of dividends. They are typically distributed to investors on a quarterly basis, making them a good interest-earning option for retirees looking for a reliable source of income. Like private corporations, REITs do not pay corporate income taxes because they frequently distribute all of their taxable income as dividends. Profits are distributed pre-tax to investors after management deductions. The long-term performance of REITs has surpassed that of corporate bonds, making them more alluring for a risk-tolerant investor. However, only 50% of the returns for the typical REIT investor come from income, even though REITs frequently have lower yields than corporate bonds. If an investor is willing to take on the risks, the other 50% comes from capital gains, which may make REITs more alluring.REIT-related risks
REITs have higher risks than equity investments because they are traded on the stock market. A variety of market forces, underlying fundamentals, and external stimuli all have an impact on how real estate prices fluctuate. The effects on prices will be mirrored by REITs, which will themselves reflect any weakness. There have been times when REITs haven't produced significant long-term returns, despite this being a possibility. For instance, when the real estate bubble burst between early 2007 and early 2009, the price of shares in the iShares Dow Jones U.S. Real Estate ETF (IYR) decreased by about 77 percent, from a high of $91.42 to a low of $20.98. Important: REITs are occasionally mistakenly labeled as "bond substitutes." REITs are securities; they are not bonds. They carry a level of risk that is significantly higher than that of government bonds, like all equities. REITs may also generate negative total returns when interest rates are high or rising. When interest rates are low, a lot of investors leave safer investments like Treasury bonds in favor of finding income in other markets, like real estate.REIT return rates
As calculated by the MSCI US REIT Index, the five-year gross return for U.S. REITs was 7.76 percent in February 2022, and the ten-year return was 9.6 percent. One of the best calendar-year total returns ever was achieved in 2021, with an annual performance of 43.06 percent. One of only two years with poor performance since 2008, it was -7.57 percent in 2020. The 9.6% return is comparable to the S&P 500 Index's historical average annual return (roughly 10 percent ). These are merely a snapshot of returns, regardless of whether they are higher or lower than others for a particular period. They only demonstrate that returns can vary and that REITs can be used in various ways, not that they are a better investment. Performance and returns matter a lot, but whether they are good or bad depends on you and how you approach investing. The best fit for your portfolio might not be what works well for other investors.Guide to Investing in REITs
There are several methods for investing in REITs. To choose from, there are exchange-traded funds (ETFs), mutual funds, and closed-end funds. Frequently used exchange-traded funds with a REIT focus include:- iShares U.S. Real Estate (IYR)
- Vanguard Residential (VNQ)
- iShares Dow Jones SPDR (RWR)
- The iShares Cohen & Steers REIT (ICF)
- Group Simon Property (SPG)
- Municipal Storage (PSA)
- Residential Equity (EQR)
- Property Healthpeak (PEAK)
- The marketplace (VTR)
Using REITs to Build Portfolios
In comparison to other market segments, REITs typically have a lower correlation. While broader market trends influence them, you can anticipate that their performance will differ somewhat from that of the major stock indices and bonds. Due to their performance, they may not be as effective a hedge vehicle as bonds or commodities, but they can still be effective. REITs can be used to boost your portfolio's yield while lowering the overall volatility of your holdings. REITs also have the potential for longer-term capital appreciation, making them an advantage over bonds purchased at issue. They might also perform better than some other investments during inflationary times because real estate prices typically increase along with inflation. Contrary to capital gains from stocks that have been held for at least a year, REIT dividends are fully taxable. A reputable financial advisor should always be consulted before making any asset allocation decisions.Most Commonly Asked Questions (FAQs)
What kind of taxes are levied on REITs?
Taxes may be applied to REIT dividends as ordinary income, capital gains, or returns on investment. Ordinary income can be used to treat the majority of dividends. Any capital gains or losses that are included in the dividend will be disclosed to you by the REIT. Capital gains tax is typically 0%, 15%, or 20%, depending on the investor's income.What are REITs for mortgages?
Mortgage REITs do not directly own any real estate. Instead, they make investments in real estate, securities backed by mortgages, and related assets. Interest on mortgages and other assets is used to pay dividends. Equity REITs are outright property owners.