How to buy REITs
Investors have many ways to invest in REITs. The easiest way is to buy shares of publicly traded REITs through a brokerage account. An investor can purchase a diversified REIT or invest in several different REITs to build a diversified portfolio. REITs are relatively inexpensive to buy, with most trading for less than $100 a share.
Another way to invest broadly across the REIT sector is to buy a mutual fund or exchange-traded fund (ETF) focused on REITs. REIT ETFs and REIT mutual funds are also easy to buy and relatively inexpensive.
Finally, you can invest in public non-traded REITs through a financial advisor or a real estate crowdfunding portal, which makes them a little more challenging to purchase. They also often have higher minimum investments, usually $2,500 or more to start.
Essential tips for REIT investment
Here are some practical tips for those looking to start investing in REITs:
- Begin with publicly traded REITs: It's best to purchase shares of a REIT in your brokerage account. These companies typically have long operating track records, report their financial results quarterly, and don't charge high management fees.
- Start small and scale up: Investors should begin by allocating a small portion of their portfolio to one REIT. They should consider adding to that position and investing in additional REITs as they grow more comfortable with the sector.
- Diversify across REIT categories: Investors should aim to build a diversified REIT portfolio across multiple property types, including residential, industrial, and retail.
- Focus on dividend sustainability: Many REITs pay high dividend yields. However, investors should focus on companies that can sustain and grow their dividends. They should look for companies that invest in high-quality properties with durable, growing demand. They should also seek REITs with conservative financial profiles.
How does a company qualify as a REIT?
Companies must meet specific criteria to qualify as a REIT, which receives special tax treatment and doesn't pay corporate income tax. These qualifications include:
- REITs must pay out at least 90% of their taxable income to shareholders as dividends each year. Many REITs will pay out more than 100% of their taxable income because their cash flow, measured by funds from operations (FFO), is often higher than income due to depreciation.
- They must be an entity that would be treated as a corporation for tax purposes.
- A board of directors or trustees must manage them.
- They must have fully transferable shares.
- They must have at least 100 shareholders after their first year as a REIT.
- REITs can have no more than 50% of their shares held by five or fewer people during the last half of their taxable year.
- They must invest at least 75% of total assets in real estate assets or cash.
- REITs must get at least 75% of their gross income from real estate-related sources, including rents from real property, interest on mortgages, financing real property, and the sale of real estate.
- A REIT must get at least 95% of its overall gross income from those real estate sources and dividends or interest from any source. In other words, 75% of its gross income must come from real estate, and only 5% can come from sources other than real estate, dividends, and interest income.
- They can have no more than 25% of their assets in non-qualifying securities or stock in a taxable REIT subsidiary.
Tax advantages of REITs
REITs have the following tax advantages:
- They do not pay corporate income taxes, enabling investors to avoid double taxation (taxing profits at the corporate level and individual level via dividend payments).
- Return of capital distributions from REITs is tax-deferred.
- REIT investors can deduct 20% of their dividends earned via the qualified business deduction.
However, a portion of a REIT's dividend payment is often a nonqualified dividend, which gets taxed at the higher ordinary rate if held in a regular brokerage account.
REITs often make great passive income investments
Congress created REITs so that anyone could own income-producing real estate. REITs must pay a dividend, making them a great way to earn passive income. Add in their diversification benefits and historical returns, and REITs can be an excellent investment option.
