Real estate has long been one of the best ways to accumulate wealth in the U.S. That remains true today, despite it being a less-than-ideal time to enter the real estate market, given macroeconomic conditions like high interest rates.
Luckily, you can invest in real estate without expending large amounts of capital buying and maintaining physical properties. That's thanks to real estate investment trusts (REITs).
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How do REITs work?
REITs are companies that own, operate, or finance income-producing real estate like residences, office buildings, malls, hotels, and warehouses. REITs allow investors to invest in diversified portfolios of properties that would otherwise cost millions or billions to access.
You could spend a substantial portion of your capital to acquire real estate or buy a REIT on the stock market for a fraction of the price and effort. Add in the fact that fractional shares have become the norm, and you can get real estate exposure for virtually as little or as much as you choose.
REITs are essentially real estate portfolios packaged into one investment. They're similar to mutual funds, which contain multiple stocks and other assets.
The major benefit of REITs
Although REITs trade on the stock exchange like other types of funds, one major thing separates them: REITs are required by law to distribute at least 90% of their taxable income to shareholders as dividends. This requirement ensures investors a steady stream of income, which isn't always the case with individual stocks or non-Treasury bonds.
REITs generate income from the properties they own or finance (think: leases). After covering relevant expenses, the bulk of remaining income goes to shareholders in the form of dividends. Like regular stocks, the dividend yield of a REIT is found by taking its annual payout and dividing it by its stock price. For example, if a REIT pays out $1 annually per share and its stock price is $20, its yield would be 5%.
It's important to remember that REITs (like all stocks) can fluctuate in value, so their yields will inevitably fluctuate as well.
A hands-off real estate approach
REITs allow investors to invest in real estate without identifying the next hot property or market. They offer investors an attractive trifecta: consistent income, diversification, and a potential hedge against inflation. Maybe more important for many people is the fact that REITs remove the need for direct property management.
While there are always risks in investing, a well-diversified REIT portfolio can provide the upside of real estate investing without the associated time and headaches of owning physical property.
Cover a lot of ground with one investment
There are tons of REITs on the stock market, catering to investors of all facets of real estate. Your choice depends on your preference, but I would lean toward an option like the Vanguard Real Estate ETF (VNQ 0.05%), which is itself a basket of over 160 REITs.
This exchange-traded fund covers a lot of sectors, including (among its top 10):
- Industrial REITs: 13.8%
- Telecom Tower REITs: 13.3%
- Retail REITs: 12.5%
- Multifamily residential REITs: 9.1%
- Data center REITs: 8.2%
- Health care REITs: 8.1%
- Self-storage REITs: 7.4%
- Other specialized REITs: 6.1%
- Single-family residential REITs: 4.9%
- Office REITs: 4.3%
Spread across so many real estate sectors, the Vanguard Real Estate ETF's diversification helps reduce some of the sector-specific risks that come with real estate. For example, office buildings have taken a hit since the pandemic as companies continue to adopt work-from-home policies. An investor concentrated in office REITs would likely have significant losses (or lackluster gains) compared to someone exposed to residential or industrial REITs.
Diversification isn't just important among asset classes, but it's also important to have diversification within your stock portfolio, REITs included.
