14 Things Investors Should Know About Investing in REITs

REIT stands for real estate investment trust. They've been around for 60 years, created by Congress so that investors of all sizes could get involved in owning real estate at an entry price as low as a single share.

REITs own and operate real estate properties of pretty much every kind, and they all have to follow one basic rule: They must pay at least 90% of their taxable income to shareholders in the form of dividends. Combine that with their liquidity compared to owning a piece of real estate directly, and REITs are ideal for passive income investment and retirement portfolios.

Here are 14 basics to understand and look for in this investment type.

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Private REITs typically require large investments and are the province of well-heeled individual investors and the firms they use for this kind of play. Then, there are public non-traded REITs that can be bought and sold through brokers and online crowdfunding portals. And then, there are more than 200 publicly traded, highly liquid REITs on the major stock exchanges.

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The publicly traded REIT world can be divided into equity REITs and mortgage REITs (mREITs). Equity REITs own and/or operate the real estate that produces the income shared with shareholders. mREITs make, buy, and sell mortgages and mortgage-backed securities. There also are REITs that do combinations of both.

Net lease and triple net lease are terms you need to understand as a basic of REIT operations and investing. That simply means the tenant pays for not only the rent but also items such as property taxes, insurance, and maintenance. They're standard practice among REITs, and they speak to the appeal of REITs as a form of passive investing.

REITs tend to specialize in a single real estate segment, some with other types mixed in depending on the opportunity presented. The basic types you'll see include retail, office, industrial, residential, healthcare, hospitality, and timberland. Subsets of those include multifamily, data centers, infrastructure (including mobile towers), senior living, hotels and motels, life sciences, and more.

There are a lot of labels, and a lot of REITs have mixtures of property types. Office and retail, for example.

REIT portfolios can be very regionally or even locally focused. There's one, for example, that owns one of the Big Apple's most iconic properties and other NYC metro office properties. Appropriately enough, it's called Empire State Realty Trust (NYSE:ESRT), and it generates a nice chunk of its income just from the famous observatory atop its namesake.

Then there's American Tower (NYSE:AMT), the largest of all REITs and owner/operator of more than 185,000 mobile towers and much more around the world.

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Currently, industrial real estate -- especially warehouses -- has been growing in importance alongside the growth of e-commerce, and global supply chain issues have just made this sector hotter.

There are many flavors here, including coastal market specialist Terreno Realty (NYSE: TRNO) and Duke Realty (NYSE: DRE), which focuses on 20 major logistics markets across the land. Depending on what's happening among industries and the economy, there can be others.

ALSO READ: Will Industrial Real Estate Stay On Top in 2022?

That Terreno Realty outfit just mentioned in the previous slide has been making a series of investments in more properties and empty lots in its market -- at several million dollars or so a pop. That's small potatoes compared with, say, AMT, which just spent $7.5 billion to buy a major data center REIT, CoreSite Realty Corp. (NYSE:COR). Those kinds of purchases make sense, adding to their existing businesses and expanding their reach into related activities.

Empty spaces make for empty coffers. That was especially the case for retail REITs whose shopping centers and malls were hit by store closings that worsened the shift from brick-and-mortar shopping to buying online that escalated sharply during the pandemic.

Some went bankrupt, and even the biggest and strongest -- including companies like mall giant Simon Property Group (NYSE:SPG) -- struggled before their fortunes turned. Simon was big enough, in fact, to buy some of its own tenants, like JCPenney. That's something to look for, too.

Retail wasn't alone in feeling the pandemic pain. Office and senior housing REITs were also hit by the shutdowns and are seeing uneven recoveries. Rent deferrals and forgiveness, combined with companies that just went under or jumped ship, dramatically lowered the take.

Look for rent-paid percentages of at least 90% in the REITs you're considering. Raising the rent is something to consider, too. Industrial REITs have been able to do that at a healthy clip. So are a lot of residential REITs. Retail and traditional office? Not so much.

ALSO READ: Raising the Rent -- and the Ceiling -- on Industrial Real Estate

Just like any publicly traded company, you'll want your REIT to show income growth, especially now that the economy is shaking off the effects of the pandemic in so many investment areas.

But gauging growth for REITs is different. Rather than net income and earnings per share -- while they're important -- the go-to metric for REITs is funds from operations (FFO).

That number is the result of taking earnings, then adding depreciation and amortization and losses on sales of assets, and then subtracting interest income and sales of assets. It's basically the critical measure of a REIT's operating profitability. Watch for it to be rising -- at least holding steady -- if considering a buy.

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Two more important measures of a REIT's performance are total return and yield. Total return is simply that: the total return your investment yields when factoring in the changed stock price, dividend distributions, and interest paid over a set period. Meanwhile, for a REIT, yield is basically the stock price divided by the dividend payout, also over a set amount of time.

Of course, how much yield you consider attractive is up to you, but keep in mind that the stock price influences it. For instance, some of the hotter industrial REITs are yielding 1% to 2%, while many others are in the 4% to 5% range. And mREITs, which tend to focus on the spread between buying and selling mortgage obligations, can easily produce yields of 8% to 10% or more. But they're also more volatile.

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Beware the cut! The current stock price and its history are, of course, important to REIT investing. But even more so to many is the dividend payout. Most REITs pay quarterly, but there are a few that pay monthly, including one of the most popular of all REITs, the giant retail landlord Realty Income (NYSE: O).

And stay particularly alert to dividend cuts. They were legion during the height of the pandemic, and they are always a risk for any REIT at any time. They rarely happen during good times, of course. REITs depend on that payout to attract and keep investors, and a cut is a great way to send them -- and their stock price -- heading down and out.

You calculate a dividend ratio for a specific period, say a quarter, by simply dividing dividends paid by net income. REITs tend to have higher payout ratios than other dividend-paying stocks of their tax structure. They're also seen as an important measure of a portfolio's ability to sustain or, better yet, grow that payout.

Payout ratios of 75% or so might seem high among other stocks, but that's typical for REITs. When it gets over 100%, start watching for dividend cuts or other moves, like reducing investment in the portfolio itself.

ALSO READ: What Is a Dividend Payout Ratio and Why Should I Care About It?

Details like payout ratios might take a little more digging or back-of-the-napkin ciphering on your own, but basics like dividend payouts, stock prices, portfolio holdings, asset investments and sales, and stock price histories are easily accessible. Quarterly reports and presentations are usually posted under the "Investors" sections of companies' websites. That's a good place to start.

REITs are a very attractive way to begin and sustain real estate investing, including the ability to focus on specific markets and/or stocks. They're a natural fit for the growth-and-income part of any portfolio, with the income generally better than you'd get from any savings account and most bonds, and offer capital appreciation if you select well, stay alert, and stick with it.

We hope this rundown of some basic info on this investment type proves useful.

Marc Rapport owns shares of CoreSite Realty. The Motley Fool owns shares of and recommends American Tower and Terreno Realty. The Motley Fool recommends Empire State Realty Trust. The Motley Fool has a disclosure policy.