Real Estate Investment Trust (REIT)

A Real Estate Investment Trust, or REIT, is a company that is set up like a mutual fund to offer real estate investment opportunities to a wide range of investors. In a REIT, the company owns and operates some income-producing real estate. A pool of investors contributes funds to the REIT to finance purchases and operations in return for a portion of the income.

REIT Investing

Congress established REITs in 1960 as part of the Cigar Excise Tax Extension. Before the creation of REITs, traditional real estate investors had to purchase and operate an entire property on their own, making it an investment opportunity only available to wealthy individuals. Modern REITs allow investors to invest a small amount of money to finance a property along with other investors, opening up real estate as a viable option for those without the time or funds to own and operate property by themselves.

REIT Example

REIT portfolios can be composed of a variety of properties, including apartment complexes, warehouses, healthcare facilities, and infrastructures such as cell towers and energy pipelines. Most REITs specialize in a particular sector of real estate, however, some diversified REIT portfolios may consist of a variety of different real estate types.

Pros and Cons of Investing in REITs

Like other financial instruments, REIT investing comes with its own set of pitfalls and advantages. Some advantages are outlined below.

  1. REITs can diversify your portfolio: Most modern theories for portfolio construction stress the need to have one that incorporates various types of assets. REITs can help you gain access to expensive real estate across industries at a fraction of their overall costs.
  2. REITs are an inflation hedge: Real estate is considered a hedge against price increases. Landlords and building owners can increase rents or tenancy costs and protect themselves against the erosion of value. The asset, in this case, real estate, becomes inflation-resistant in the process. According to research from investment firm Morningstar, inflation averaged 8% between 1972 and 2019. The FTSE Nareit US Real Estate Index Series returned an average of 10.6% during the same period.
  3. REITs have a low correlation with equities: REITs are considered an alternative asset, meaning they have a low correlation with assets, such as equities, that are favored by investors for returns. Therefore, they are attractive for investors looking for a place to park their funds during stock market downturns.

The disadvantages of investing in REITs are as follows:

  1. REIT returns are affected by economic downturns: REIT returns are dependent on economic cycles and, therefore, they perform badly during economic recessions. For example, real estate prices crashed after the 2008 financial recession. Commercial real estate bore the brunt of those losses because lender operations were hemmed in losses and increased regulatory oversight.
  2. REITs have interest rate dependency: The interest rate risk in REITs is tied to their dependency on the overall economy. Thus, REITs fail to act as an appropriate hedge when the economy is undergoing a recession.
  3. Private REITs may be illiquid and fraudulent: Because they do not have to disclose information to the SEC and are not traded at public exchanges, private REITs do not have a readily available market. The absence of disclosures can also mean that distributions or dividend payouts may not be made from income generated from operations.
  4. REITs are low-income growth instruments: As an asset, real estate does not have the returns or growth trajectory of stocks. Growth is generally slow and, in the case of REITs, measured as it is divided among multiple stakeholders.
REIT stands for Real Estate Investment Trust.
A Real Estate Investment Trust, or REIT, is a company that is set up like a mutual fund to offer real estate investment opportunities to a wide range of investors.
A pool of investors contributes funds to the REIT to finance purchases and operations in return for a portion of the income.
Modern REITs allow investors to invest a small amount of money to finance a property along with other investors, opening up real estate as a viable option for those without the time or funds to own and operate property by themselves.
REIT portfolios can be composed of a variety of properties, including residential, commercial, apartment complexes, warehouses, healthcare facilities, and infrastructure such as cell towers and energy pipelines.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.