Listing remarks
- REITs must distribute at least 90 percent of their taxable income each year, according to Investor.gov.
- Non-traded REITs typically do not give an estimate of value per share until 18 months after their offering closes, the SEC says.
- REIT dividends generally do not qualify for the lower tax rate on qualified dividends.
Key takeaways
- A REIT is a company that owns, and often operates, income-producing real estate.
- Publicly traded REITs can be bought and sold on an exchange; non-traded REITs generally cannot.
- REIT dividends are usually taxed as ordinary income.
- The SEC urges extra caution with non-traded REITs: fees, illiquidity and distributions that may come from borrowed money.
Not everyone who wants real estate in their portfolio wants a tenant’s phone number. A real estate investment trust, or REIT, lets you buy shares in a company that owns property, from apartment complexes and shopping centers to warehouses and office towers. You share in the rent without fixing a single faucet. The SEC’s investor education site, Investor.gov, explains how they work and where the risks are.
How a REIT works
A REIT pools money from many investors and uses it to own and often operate income-producing real estate. Because of the rules REITs are set up under, Investor.gov says they must distribute at least 90 percent of their taxable income to shareholders each year, and many pay out more. The income that is distributed is generally not taxed at the company level, which avoids the double taxation of a typical corporation. Shareholders pay tax on what they receive.
Three ways to own REITs
| Type | How you buy it | What to know |
|---|---|---|
| Publicly traded REIT | Through a broker, on a stock exchange | Price is visible every trading day and shares can be sold quickly; the price moves with the market |
| Non-traded REIT | Through a broker taking part in the offering | Not listed on an exchange; hard to sell and hard to value |
| REIT mutual fund or ETF | Through a broker or fund company | Holds many REITs at once for more diversification |
Brokerage fees apply when you buy publicly traded REIT shares. Non-traded REITs are typically sold by a broker or financial adviser, and Investor.gov says their sales commissions and up-front offering fees usually total about 9 to 10 percent of the investment.
The case for REITs
- No landlord work. Management is professional.
- Diversification. One share can represent many properties in many places.
- Income. The distribution requirement means regular dividends are common.
- Liquidity, for traded REITs. You can sell on any trading day.
- Small amounts. You can start with the price of a share rather than a down payment.
The risks
Market and interest rate risk
A publicly traded REIT is a stock. Its price can fall with the market even when its buildings are full. Investor.gov notes that REITs may be sensitive to changing interest rates, and that different REITs can be affected differently.
Taxes on dividends
REIT dividends generally do not qualify for the favorable tax treatment of qualified dividends, according to Investor.gov. Depending on your situation they may be taxed at your ordinary income rate. A tax professional can tell you how REIT dividends fit your own return.
Non-traded REITs: special caution
The SEC’s investor bulletin on non-traded REITs lists risks a buyer should understand before investing:
- Lack of liquidity. Shares cannot be sold readily in the market. Investors generally must wait until the REIT lists its shares on an exchange or sells its assets.
- Hard to value. Non-traded REITs typically do not provide an estimate of value per share until 18 months after their offering closes.
- Distributions from borrowed money. High yields can be paid partly from offering proceeds or borrowing rather than from operations, which reduces the money available to buy property.
- Fees and conflicts. The SEC’s bulletin says up-front fees can represent up to 15 percent of the offering price, and an external manager may be paid based on acquisitions and assets under management.
Tip: Before buying any REIT, read its prospectus and recent annual and quarterly reports, which are filed with the SEC and searchable on its EDGAR database. Investor.gov also suggests checking the background of the broker who sells it.
REITs vs. owning a rental
A rental gives you control, leverage and direct tax deductions such as depreciation, at the cost of work, concentration and illiquidity. A traded REIT gives you diversification and easy exit, at the cost of control and with market swings you cannot manage. Many investors hold both. For the direct route, see Buying Your First Rental Property: From Search to First Tenant; for a newer pooled option, see Real Estate Crowdfunding: How It Works and What the SEC Warns.
Watch for approval claims
The SEC never approves an offering. Its investor alert warns about promoters who present SEC filings as a stamp of approval: a filing on EDGAR does not confer any special status, and the SEC does not judge whether a security is a good investment.
The bottom line
REITs are the simplest way to add real estate to a portfolio without becoming a landlord. Publicly traded REITs trade like stocks and carry stock-market risk. Non-traded REITs deserve much more scrutiny because they are hard to sell and value. Read the filings, understand the tax treatment and compare the trade-offs in Real Estate Investing Pros and Cons: An Honest Look.