How does adding an investment to your portfolio that may provide regular current income, long-term appreciation and portfolio diversification sound? We’d say pretty good by most standards (keeping in mind that all investments are speculative and may lose value), and it’s what adding commercial real estate to traditional stock and bond portfolios has the potential to do.
What’s the catch though?
Unless you have millions of dollars to spare (which most of us most likely don’t), going out and buying a high-rise office building or retail property on your own is probably not an option. But that’s where real estate investment trusts come in.
A real estate investment trust (REIT) is most commonly defined as a “company that owns, operates or finances income-producing real estate” and is required to pay out 90% of its taxable income to shareholders. REITs allow individuals to invest in commercial real estate assets in a manner similar to what they are used to with other investments, like purchasing individual company shares or by participating in mutual or exchange traded funds.
The simplest way to think of a REIT is that it is similar to a mutual fund – money is pooled, invested in a variety of assets (properties) and investors receive dividend distributions.
Types of REITs
Not all REITs are created equal and can typically be classified by:
What they invest in: Equity or mortgages. Equity REITs directly own real estate assets and earn income through tenant rent payments and property value appreciation. Mortgage REITs invest in mortgages, mortgage-backed securities and other related assets, and earn income by collecting principal and interest payments from borrowers.
How they trade shares: Listed, non-listed and private.
- Listed REITs can be bought and sold on public stock exchanges like the NYSE or NASDAQ and are regulated by the Securities Exchange Commission (SEC). Modiv is a publicly listed REIT.
- Non-listed REITs are not traded on public stock exchanges but can be purchased through the REIT’s management company or a third-party broker by most investors. Non-listed REITs are still required to register with the SEC and must file regular reports like listed REITs. They are less liquid than listed REITs, but may have less price volatility because they may be less subject to fluctuations in the stock market.
- Private REITS are not listed on stock exchanges nor do they have to file with the SEC, which may make them difficult to value and trade, and are generally only available to accredited investors or institutional investors.
What sectors they specialize in: Office, retail, industrial, multifamily, healthcare, hospitality, data centers, senior housing, cell phone towers and almost every other commercial property type imaginable can be found in a REIT. A REIT’s investment strategy often dictates the types of properties it invests in. REITs can also invest in a variety of different sectors within one fund earning the title of a “diversified” REIT.
WHY REITS ARE A POPULAR CHOICE FOR REAL ESTATE INVESTORS
While exposure to commercial real estate investments can be beneficial, doing so through a REIT may have advantages over owning and managing individual properties on your own.
While we have only covered the basics of REIT types and sector specializations above, you can see that this investment vehicle offers a wide array of combinations from which to choose. But one common factor among all REITs is that they extend a potentially powerful opportunity to individual investors: the ability to add institutional-quality real estate to their investment portfolios without having to directly buy, manage or finance physical properties. A REIT can provide diversification in and of itself across the number, type and location of properties in a fund, a benefit that may be difficult to achieve with direct ownership. With a single purchase of REIT shares, an investor can potentially gain access to multiple real estate assets professionally managed by real estate experts.
Diversification and Returns
Historically, REITs have delivered competitive returns, attributable to consistent dividend income and long-term appreciation, and outperformed the leading benchmarks for U.S. stocks and bonds as demonstrated in the chart below. REITs represent an important asset class that may provide portfolio diversification because of its potential to provide low correlation with other investments, effectively reducing volatility and increasing risk-adjusted returns.
In addition to the portfolio benefits mentioned above, REITs may also provide tax benefits when compared to other investments. Remember that to be classified as a REIT, a fund has to distribute at least 90% of its taxable income to shareholders. Because of this, REITs are considered pass-through entities and pay no corporate taxes. Income is distributed to investors through dividends, which are taxed at the individual level. With dividend distributions of a typical corporation’s shares, investors are essentially taxed twice – at the corporate level and individual earnings level. Because of their special tax structure, REITs allow investors to keep a larger percentage of their returns. The Tax Cuts and Jobs Act of 2017 has also rewarded REIT investors with additional benefits, namely that the income received from REIT dividends can be considered qualified business income and investors can receive up to a 20% deduction. That means that if an investor received $1,000 of income from REIT dividends, as little as $800 could be taxable.2 Be sure to discuss the potential tax benefits of REIT ownership with your CPA or tax advisor, as they may be able to provide additional insight and guidance.
TO SUM IT ALL UP
Accessibility to REITs and their affordability varies by how shares are traded – publicly, privately, to accredited investors or to everyone. When choosing to add real estate to your portfolio through REIT shares, it is important to have a good understanding of all the options available, what sponsor fees exist, and how the REIT can complement your existing investing strategy. Your financial advisor may have additional suggestions on how REITs may benefit your overall investment profile.
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The views and opinions expressed in this commentary reflect Modiv Inc.’s (together with its affiliates, “Modiv”) beliefs and observations in commercial real estate as of the date of publication from sources believed by Modiv to be reliable and are subject to change. Modiv undertakes no responsibility to advise you of any changes in the views expressed herein. No representations are made as to the accuracy of such observations and assumptions and there can be no assurances that actual events will not differ materially from those assumed. The forward-looking statements in this paper are based on Modiv’s current expectations, estimates, forecasts and projections, and are not guarantees of future performance. Actual results may differ materially from those expressed in these forward-looking statements, and you should not place undue reliance on any such statements. These materials are provided for informational purposes only, and under no circumstances may any information contained herein be construed as investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any Modiv program or offering. Alternative investments, such as investments in real estate, can be highly illiquid, are speculative, may not be suitable for all investors, and there is no guarantee that distributions will be paid.