A Comprehensive Guide to REITs: Benefits and Drawbacks

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What Is a Real Estate Investment Trust?

A Real Estate Investment Trust (REIT) is a company that invests in a variety of income-generating properties, both residential and commercial. Investors can put their money into medical offices, gas stations, movie theaters, storage facilities, farmland, casinos, and many other types of properties.

REITs generate income from the properties they own and distribute at least 90% of it to their shareholders. Many REITs pay out all of their earnings due to the tax benefits. Since many REITs are listed on major stock exchanges, investors can also earn returns from share price appreciation. Some REITs are public but not listed on an exchange, while others are private and not accessible to the general public.

Pros of REITs

Portfolio Diversification

Investing in REITs can help diversify your investment portfolio beyond the stock market. By including REITs along with other types of investment securities, you can mitigate some of the risks associated with each type of asset. For instance, the stock market tends to be more volatile in the short term compared to the real estate market, allowing you to balance more and less risky investments.

Additionally, REITs offer real estate investors a chance to diversify their holdings, which is challenging when buying individual investment properties that require a large amount of cash.

Accessibility

With REITs, investors interested in the real estate market don’t need to save up tens of thousands of dollars for a down payment on an investment property or make regular mortgage payments. Depending on the broker, you may even be able to buy fractional shares of a REIT if you can’t afford a full share.

Passive Income

As a REIT shareholder, you’ll receive regular dividends—monthly, quarterly, or annually—based on your holding in the company. If you’re nearing retirement or want to build a passive income stream, REITs can be an excellent way to receive regular income without active involvement.

Liquidity

Unlike traditional real estate investments, REITs allow you to buy and sell shares easily through your brokerage account. Selling an investment property can take several months and a significant amount of cash, but REITs offer more flexibility and quicker access to cash if needed.

Competitive Returns

In addition to regular income payments, REIT investors can benefit from price appreciation of their shares. Many REITs outperform the stock market in terms of annualized returns, especially when held for 10 or more years.

Cons of REITs

Dividend Taxes

REIT dividends are subject to your ordinary income tax rate, which depends on your tax bracket. Because dividends are paid out regularly, you’ll have to pay taxes on the income each year, even if you reinvest your dividends. In contrast, long-term capital gains from stocks are taxed at a lower rate.

Interest Rate Risk

The value of a REIT is tied to the real estate market. If interest rates rise and demand for properties decreases, it could lead to lower property values, negatively impacting your investment.

Market Volatility

While REITs generally experience less short-term volatility than stocks, the real estate market is still subject to various influences. You’ll still face market volatility with a REIT, which could affect you in the short term.

Lack of Control

Investing in a REIT is similar to buying a mutual fund or exchange-traded fund; you have no say in how the REIT invests its money or manages the properties. Some REITs focus on specific niches, such as office buildings or apartment complexes, which may limit diversification.

High Fees

Publicly traded REITs typically have minimal fees beyond trading commissions, which many online brokers no longer charge. However, non-listed or private REITs can have upfront costs as high as 11% or more of your investment and may charge a 2% annual management fee.

Navigating REIT Investing

Investing in REITs can diversify your portfolio, provide passive income, and offer liquidity and excellent long-term returns. However, taxes can be higher with REITs compared to other investment options, and there are risks associated with the real estate market.

If you’re considering adding REITs to your portfolio, research several options. Look at past performance, dividend yields, and property holdings to understand what you’re getting into. Consulting with a financial advisor can also provide personalized expert advice and guidance for your situation and financial goals.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your investment journey with confidence.

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