Real Estate Investment Trusts continue to show sustained popularity with investors seeking income and returns. In fact, the Wall Street Journal reports that the funds managed more than $224 billion by the end of 2021. Among the motivations for shareholders are the desire to own commercial real estate, the pursuit of truly passive income, and returns that have often outpaced increases in the cost of living. Some investors who have held real estate and managed it actively prefer to transition to REIT participation as a way to maintain their real estate involvement without the need to remain involved with tenants directly.
REITs originated in legislation passed in 1960. A REIT is a company that seeks to generate income for its investors by owning and operating (or financing) real estate properties. The structure offers investors the ability to access fractional ownership of commercial assets without management responsibility. Instead, the REIT sponsor determines the strategy and executes it. In the more common type of REIT, which owns property, the assets may be mult-family housing, retail malls, hotels, office parks, industrial complexes, even self-storage centers or cellular service towers. Other REITs instead buy and sell financial instruments like mortgages. A hybrid of the two combines both property and debt ownership.
REITs are often traded on stock exchanges, which offers access to any investor for the price of a share. There are also private and non-traded REIT funds, but those are restricted to accredited investors who qualify. Publicly traded REITs are liquid—you can usually sell your shares on demand, but the non-traded funds must be considered illiquid and may have long holding periods.
REITs enjoy pass-through tax status, which means that their income is not taxed at the corporate level. Instead, it is passed through to the individual investors, who pay taxes at their earned income rate. However, for a REIT to maintain that operating status, it must adhere to these rules:
Interest rate fluctuations and other economic changes may affect REITs and other investments. It’s challenging to predict the direction and level of that impact. High or rising interest rates may harm real estate values, which can potentially carry over to the returns obtained by funds that invest in property. A REIT that focuses on mortgages and financial instruments may feel the impact more quickly than one that owns properties. Some REITs seek to hedge their investment strategy by owning assets across regions, sectors, or classes. Investors should choose a fund managed by a sponsor they consider trustworthy.