15 Must-Knows Before Investing in REITs

Congress created real estate investment trusts (REITs) to allow individuals to invest in income-producing commercial properties without buying and managing the properties themselves.

Interestingly enough, the enabling legislation was contained in the Cigar Excise Tax Extension of 1960 -- and REITs have been delivering returns to shareholders that, at times, have indeed been smoking hot.

But a slow burn is more like it, as savvy buyers of these stocks have long learned how to profit from the steady income and share price appreciation this real estate investing option has provided now for a half-century.

Here are some things unfamiliar investors should know about REITs.

5 Stocks Under $49

Presented by Motley Fool Stock Advisor

We hear it over and over from investors, "I wish I had bought Amazon or Netflix when they were first recommended by The Motley Fool. I'd be sitting on a gold mine!" It's true, but we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Click here to learn how you can grab a copy of "5 Growth Stocks Under $49" for FREE for a limited time only.

REITs make their money buying, selling, owning, and/or operating real estate that they then lease to tenants, creating an income stream that by law must be shared with investors. They are often involved in financing real estate for other buyers, too.

ALSO READ: Real Estate Investment Trusts: What They Are and How to Invest in Them

The IRS requires REITs to pay out at least 90% of their taxable income to shareholders. Other requirements include investing at least 75% of their total assets in real estate or cash and generating at least 75% of their income from rents, interest from financing properties, and sales.

ALSO READ: Like Dividends? I Bet You'll Love These 2 REITs

The National Association of Real Estate Investment Trusts (Nareit) -- the major REIT trade association -- says more than 225 publicly traded REITs are registered with the SEC, with a combined market cap of more than $1 trillion.

There also are more than 900 non-publicly traded REITs, which typically require minimum investments and can have holding requirements of a year or more to keep the money in-house and let strategies do their work.

Non-traded REITs typically have a steadier net asset value (NAV) price than equity exposed to the swings of market sentiment on the big exchanges. In contrast, publicly traded REITs offer the liquidity and simplicity that any equity does when being bought and sold on the big exchanges.

There's also the transparency that comes with regular quarterly reports, earnings calls, and other information that any publicly held company must provide.

REITs are generally considered income stocks, more turtle than hare. That doesn't mean their stock prices won't go up over time. They typically do. But they're often chosen to provide diversification in an income-focused portfolio at higher rates -- and, of course, some higher risk -- than fixed-income investments such as bonds and CDs.

5 Stocks Under $49

Presented by Motley Fool Stock Advisor

We hear it over and over from investors, "I wish I had bought Amazon or Netflix when they were first recommended by The Motley Fool. I'd be sitting on a gold mine!" It's true, but we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Click here to learn how you can grab a copy of "5 Growth Stocks Under $49" for FREE for a limited time only.

One of America's most prominent landmarks, the Empire State Building, is owned by a REIT appropriately named Empire State Realty Trust. The same applies to Ryman Auditorium and the Grand Ole Opry -- owned by Ryman Hospitality Properties. A number of huge casinos and hotel properties on the Las Vegas Strip are owned by multiple REITs. And REITs are also major owners of farmland and even digital billboards.

ALSO READ: 7 Surprising Things Owned by REITs

REITs typically specialize. You can find REITs that own:

• Self-storage facilities.
• Hospitality properties like hotels and resorts.
• Nursing homes, hospitals, and other healthcare properties.
• Retail properties like shopping centers and malls.
• Office properties
• Warehouses

You can even find REITs that own multifamily and single-family residential developments and rentals.

Warehouses are a particularly hot market right now, with demand exceeding supply nationally as e-commerce overwhelms the global supply chain wracked by a pandemic. That's attracted huge institutional and private equity money into that market, driving up share prices and rental income for multiple REITs.

A good example is the largest in that sector: Prologis. But there are many others with their own niches, including Terreno Realty, a specialist in small warehouses in several key coastal markets.

ALSO READ: Investing in Industrial REITs

Some REITs are particularly prominent in their niches. That includes Americold, which specializes in refrigerated warehouses. But there are some much larger options for investors to consider.

That includes Alexandria Real Estate Equities, a major provider of specialized office and lab space to big pharma and other companies dependent on collaborative campuses for research and development.

And the biggest REIT of all -- American Tower -- is one of three REITs that are among the largest owners of mobile towers and related technology in this country and across the world.

A well-chosen REIT can have great staying power, making them the kind of investment that offers great prospects for beating the market in the long term.

And that's not just compared to bonds and savings instruments. Nareit says REITs have outpaced the S&P 500 in total return since 1972. Total return, of course, includes changes in stock price plus dividends.

5 Stocks Under $49

Presented by Motley Fool Stock Advisor

We hear it over and over from investors, "I wish I had bought Amazon or Netflix when they were first recommended by The Motley Fool. I'd be sitting on a gold mine!" It's true, but we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Click here to learn how you can grab a copy of "5 Growth Stocks Under $49" for FREE for a limited time only.

Right now, REITs are yielding an average of about 3%, beating the S&P 500 by a significant margin. (Of course, unless they’re a REIT, members of that index are not obliged to offer a dividend.) But mortgage REITs (mREITs) offer a much higher yield, currently averaging about 8% to an eye-popping 18% or so. mREITs are very different animals.

mREITs buy, sell, and finance mortgages and mortgage-backed securities and make their money off the spread between what they pay to borrow and what they charge to lend. Some are very large and well-proven, but they also can be more volatile than REITs that hold physical real estate.

ALSO READ: 5 High-Yield Dividend REITs to Watch

Yield is a closely followed measurement for REITs and other stocks, and for good reason. It's the product of dividing a stock's price by its dividend payout over a set period of time. But keep in mind that rising prices drive down the yield, while falling prices push that percentage up. So, two REITs, or any other stock, can have the exact same dividend but very different yields.

Two major metrics REIT investors should pay attention to are payout ratio and funds from operations (FFO).

The payout ratio is the percentage of net income used to reward shareholders with dividends. Because REITs must pay dividends, their payout ratios can be much higher than those expected of other equities. But beware of one that gets close to or exceeds 100%: The company could be extending itself to keep up the dividends -- and that means a cut could be in the offing.

FFO is how a company defines cash flow from its operations and is considered more important for judging a REIT’s profitability than net income, which typically is of greater importance for the rest of the public equity universe.

ALSO READ: What Is the Difference Between FFO and Cash Flow?

Payout ratios and FFO are not the only concepts that investors reading up on REITs frequently encounter. Close attention is also paid to net leases and occupancy rates and rents.

Net leases are standard in the REIT industry. They require the tenant to pay taxes, insurance, and maintenance. Occupancy rates, meanwhile, speak to how full a portfolio's properties are. And finally, rents are often dissected in company reports to speak to how much income is coming in and how much of the rent is being paid. In inflationary times, it's particularly important to see that rise.

While most REITs pay their dividends quarterly, 10 or so have been paying them monthly. That's a great way for people who get the rest of their income that way -- like the tens of millions of Americans on Social Security -- to choose a smooth revenue stream.

Perhaps most prominent among those monthly payers is Realty Income, a highly regarded, widely held REIT that describes itself as "The Monthly Dividend Company" and has been doing just that for more than 50 years.

5 Stocks Under $49

Presented by Motley Fool Stock Advisor

We hear it over and over from investors, "I wish I had bought Amazon or Netflix when they were first recommended by The Motley Fool. I'd be sitting on a gold mine!" It's true, but we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Click here to learn how you can grab a copy of "5 Growth Stocks Under $49" for FREE for a limited time only.

REITs are now engaged in nearly every aspect of commercial and residential real estate, including the hottest of sectors. That, plus their half-century record of providing individual investors the ability to enjoy steady income and growing wealth, make them attractive destinations now for new money, too. A well-chosen group of these stocks can help any portfolio achieve greater diversification and predictable income, with some growth to boot.

Marc Rapport owns Alexandria Real Estate Equities and Terreno Realty. The Motley Fool owns and recommends American Tower, Americold Realty Trust, Prologis, and Terreno Realty. The Motley Fool recommends Alexandria Real Estate Equities, Empire State Realty Trust, and Ryman Hospitality Properties. The Motley Fool has a disclosure policy.