How to Invest in REITs

Real estate investment trusts (REITs), pronounced “REETS," are companies that own moneymaking real estate properties. REITs give individual investors a way to invest in real estate without needing to buy property or become a landlord. Most REITs trade on major stock exchanges and have historically performed well, which makes them a good choice to help diversify your portfolio.

REITs mostly represent commercial and residential real estate companies that are designed to generate cash flow from rents. REITs are generally diversified across a range of properties. For investors, in most cases, REITs have the benefit of liquidity, making this investment vehicle more like purchasing stocks than buying physical real estate.

Congress established REITs in 1960 to give middle-class Americans an affordable vehicle to invest in income-producing real estate.1 The Tax Reform Act of 1986 allowed REITs to not only own and finance real estate but to also manage and operate it. Today, REITs are in about 40 countries.

About 43% of American households own REITs.1 If you're interested in becoming one of them, learn more about how REITs work, how well they tend to perform, and how to invest in them.

How do REITs work?

REITs typically generate income by leasing space and collecting rent, paying their stockholders in dividends.

By federal law, REITs must pay at least 90% of their taxable income in shareholder dividends. REITs are typically traded on the major stock exchanges. This can be through stocks in individual real estate companies or through index funds, mutual funds, or ETFs that hold stocks from a variety of different real estate companies.

There are also private REITs that are generally sold only to institutional investors, entities that accumulate funds from a large number of investors and invest on behalf of those members. There are also public non-listed REITs that don't trade on the major stock exchanges. People who want to buy public non-listed REITs should go through their broker or financial advisor as there are many things to consider when buying non-listed REITs.

To be classified as a REIT, a company must adhere to a variety of rules and regulations Some of the common considerations for REITs, include:2

• Be structured as a corporation
• Be managed by trustees or a board of directors
• Invest at least three-fourths of their assets in real estate
• Derive at least three-fourths of their gross income from real estate assets and cash
• Pay at least 90% of their taxable income as dividends to shareholders each year
• Have at least 100 shareholders, after the first year of existence
• Not have five or fewer shareholders owning more than half of their stock.

How have REITs performed over the years?

REITs have historically performed well over the long term and have generally out performed the stock market over the past 45 years, according to Nareit, the worldwide voice of the REIT industry.3 Kiplinger reports that real estate has been one of the best-performing investments over the past 20 years, posting richer returns than the S&P 500 Index, growth stocks, value stocks, bonds, and gold.4

REITs, in addition to producing income from rents, also benefit from property appreciation. Over a 30-year period ending December 31, 2020, the total average REIT annual return (which includes both equity and mortgage REITs) has been about 9.6%. The total average annual return of just equity REITs during that same time has been about 10.1%.5

When broken into categories, from 1994 to 2020, the best performing REIT type has been self-storage, with an annualized total return of 15.1%. Residential is next at 11.2% followed by healthcare and industrial, both at 10.9%.5