If you are interested in investing in real estate, but you don’t have the capital to purchase property outright, you might want to consider investing in a Real Estate Investment Trust (REIT). You have exposure to real estate, but you don’t need tens of thousands of dollars to get started.

Real Estate Investment Trust

A REIT is basically a collection of investments related to real estate. REITs include investments that might include:

  • Mortgage securities
  • Commercial property
  • Residential property
  • Stocks of real-estate connected business, such as mortgage lenders or storage companies
  • International properties

REITs can be public or private. However, even though there are a number of similarities to funds, REITs aren’t classified as such. REITs also provide the convenience associated with the ability to trade on stock exchanges. This means that you can buy and sell with relative ease.

Advantages of REITs

One of the greatest advantages to REITs is that you can invest in real estate assets without needing a large amount of capital. Additionally, you get the benefit of diversity when you invest in REITs. As with funds, it is wise to find out what collection of investments is held in a particular REIT, though.

Another advantage is that REITs can pay dividends that are quite high. REITs enjoy special treatment, and, as a result, they are required to pay 90% of their taxable income to investors. In most cases, this is done in the form of dividends for shareholders. So, when you are invested in a REIT, you receive regular dividend payments, on top of the possible increases that come with increased value on the market.

It’s also worth noting that many REITs offer DRIPs. This means that the dividends that are paid out are automatically reinvested into the trust. As a result, you build up your shares so that you have more of them. When you are ready to sell, this can make a big difference in how much money you end up with.

More after the graphic

What are REITs?

Disadvantages of REITs

As with all other investments, there are some drawbacks associated with investing in REITs. One of the main drawbacks is that REITs are highly correlated to the real estate market. So downturns can result in lost value. REITs might cut their dividends as well, when the economic conditions result in a reduced cash flow. You are exposed to the vagaries of real estate related business issues when you invest in REITs.

Another consideration is that many REITs don’t grow as fast. REITs can only invest up to 10% of their profits in the business, so reinvestment can’t be used to grow the business — and grow value. The result is that you might not see as much growth as is offered by other investments on a stock exchange.

Choosing REITs for Your Portfolio

Anytime you invest in anything, you should do your homework. Consider the fundamentals of the REIT involved, including the management. It’s important to look at the investments in the REIT in order to ensure that what you add to your portfolio fits in with your long-term investing goals. Some of the items to keep in mind as you choose REITs include:

  • Management of REIT
  • Valuation
  • Probable growth in the future
  • Dividend payout ratio
  • Dividend growth over the past five years
  • Diversification across geography

You should also consider the needs of your portfolio. You want your REIT to balance out weaknesses in your portfolio, and provide something — diversity, safety, growth — that your portfolio doesn’t already have. Consider your investment goals, and choose REITs that help you reach your objectives. Also, be aware that you could end up losing money. Anytime you invest in anything, there is the risk of loss.