There is a lot of confusion about Real Estate Investment Trusts (REITs) and we wanted to take a moment to explain the differences before moving forward. While you can buy shares of REITs on the stock market like any stock, there are also options to invest your money directly with the REIT outside of the stock market.
We will focus on the public REITs that are registered with the Securities Exchange Commission (SEC) but are not listed on any stock market exchanges. Private REITs are not registered with the SEC but work the same way and money is raised like a private investment. So…what are they exactly?
What are Public REITs?
REITs are corporations with real estate related asset portfolios that outside investors can obtain a percentage of. There are equity REITs that own physical properties, mortgage REITs that own mortgages, and hybrid REITs that own both properties and mortgages.
There are a lot of qualifiers to become a REIT such as having 75% of assets and income being related to real estate, having more than 100 shareholders, and needing to distribute 90% of taxable income to investors (which is good for our passive income aspirations) in the form of dividends to name a few. Depending on when you acquire ownership of a REIT that is not common stock, there is a time limit to the acquisition of the assets, thus you will be able to borrow this income for a specific period of time.
How does this grow my passive income?
While the law does require REITs to pay 90% of their income to you, the distribution timing is on their terms. Some dividends pay out monthly, quarterly or annually which will be important to know if you plan on using this income to pay bills or to achieve other ambitious goals you have.
Just like stock dividends, these dividends are taxed as ordinary income with none of the passive losses passed on to you to offset the income like a private investment would. As you increase your ownership percentage within a single or multiple REITs, more of the distributable income will be allocated to you.
Why would I want this passive income stream?
Besides leaving the pressure on professional operators to generate cash flow for you, it’s also a huge benefit to not see the valuation of your shares. There are publicly traded REITs you could buy, but the value of those shares are adversely affected by the whims of other investors and broad economic factors that manipulate the stock market valuations.
Having a REIT that has uncorrelated returns provides a great opportunity to diversify your portfolio in the event of a downturn in the market. You won’t have to see the value of your investment going down in real time which reduces the likelihood of you making an emotional decision to sell during the tough times and allows you to focus on the cash flow you are still receiving.
Another reason you may consider buying a public REIT, and not a private one, is for the fact that public REITs typically have lower minimums needed to invest so this just might be the only option in the beginning for you. Especially if you are already heavily invested in stocks and looking to diversify.
Risks and Considerations
Since these products focus on dividends, you will want to consult your tax advisor before making a significant investment. Reason being that if you increase your income, you may push yourself into a new tax bracket and be taxed at a higher rate. When talking with tax advisors, it’s better to ask “how” instead of “what”. Example: How do I [increase my income, invest in REITs, etc.] without increasing my taxes? If they don’t have an answer….might be time for a new advisor!
These portfolios may have one or many projects they are funding, so proper due diligence will be a key factor in helping you make a wise investment decision. Reading through the investment offer to find the timing of dividends, what assets are being invested in, and the longevity or background of the management group operating the REIT will all aid you in finding the right REIT to meet your needs.
One site, out of many, that is making it easy to find REITs and other real estate projects to invest in is Fundrise. No accreditation is needed and they vet managers before offering their projects on the site.