Are REITs a Good Investment?

REITs are a popular alternative investment option. They can provide exposure to the real estate market without the need to own and manage property directly. But are REITs a good investment? That depends on your financial situation, goals, and current holdings. Learn more about REITs, including historical average REIT returns and the pros and cons, to determine if investing in a REIT is a good choice for your portfolio!

What Is a Real Estate Investment Trust (REIT)?

A REIT, or Real Estate Investment Trust, is an asset that allows an investor to invest their capital into a real estate portfolio. Real estate companies open, own, and manage REITs and operate similarly to a mutual fund. Investors will allocate capital toward the fund, and the manager of the REIT will use that capital to acquire properties (Equity REITs) or fund mortgage loans (Mortgage REITs). Many REITs pay monthly dividends, though some may pay them annually. As the REIT performs well, investors may also profit from its rising value.

There are many different types of REIT investments, and a REIT will typically focus on one type of property. For example, a commercial REIT will focus on buying office spaces, retail locations, and manufacturing properties. A residential REIT may own single-family homes and multi-tenant apartment complexes. Certain real estate investment trusts may also focus on specific locations or investments with different levels of risk.

Some REITs are publicly traded and available to any investor. They may have smaller minimum investments. Private REITs, on the other hand, are only available to accredited investors and have much steeper minimum investments. 

When investing in a REIT, investors do not own any fraction of the properties held in the trust. They only own a share of the entire portfolio. However, REITs allow investors to passively generate income by investing in an actively managed fund. Their capital will be exposed to the real estate market, which can be great for generating income and diversifying your assets without the hassle of managing a property.

Historical Returns

Over the past 20 years, REITs have a track record of outperforming the U.S. stock markets. The average annual rolling return between 1990 and 2020 fluctuated mostly between 10% and 12%, whereas stocks fluctuated between 5-9% average annual rolling returns. REITs also appear less risky, with a 6% standard deviation of REIT returns over the past 20 years. The standard deviation of returns for U.S. stocks between 1990-2020 was 13.8%.

REITs finished 2023 with a total return of 11.5%. So far in 2024, REITs have experienced negative returns of -4.3% as of May 2024. Data shows that while REIT returns can experience short-term volatility, they historically experience long-term growth. They may not be the best option for investors looking for a short-term way to grow their capital but may provide significant capital appreciation over the long term.

It’s also important to note that REITs can be split into several different sectors, including residential, retail, health care, self-storage, office, and industrial. Each sector may perform differently depending on the overarching economic environment.

Pros

There are several advantages to REIT investments, such as diversification and passive investing. 

High Returns

Historically, REITs have had an average annual rate of return of over 10%. These high average REIT returns can help investors grow their wealth and achieve their financial goals. It’s important to note that REITs may experience short-term volatility but have continued to grow over the long term.

Diversification of Assets

If all your capital is invested in the stock market, there’s nothing to protect your capital when the market experiences a downturn. REITs are an alternative asset that provides exposure to the real estate market. The real estate market reacts to economic trends differently than the stock market and may help protect your assets. Having investments in different markets and sectors can mitigate risk during times of economic trouble.

Accessibility and Transparency

Public REITs are accessible and can be bought and sold with most standard brokerage accounts. Different REITs will have different investment minimums, but some may allow you to invest for under $100 per share. This makes REITs accessible for the average retail investor and provides low-cost exposure to the real estate market. REITs also tend to be very transparent investments, where you can easily track their growth.

Passive Income

Once your capital is invested in a REIT, you can sit back and receive your dividends. Most REITs pay them monthly or annually. You can then reinvest the dividends or use them to supplement your income. You don’t have to manage your investment actively, though it’s good to regularly check its performance and ensure it continues to be a good fit for your portfolio.

High Liquidity

Publicly traded REITs are also very liquid. They can be bought and sold as easily as stocks through most brokerage accounts. If the investment no longer fits your needs or you need quick cash, you can easily sell your shares during the normal trading day. It’s recommended to maintain some liquidity in your portfolio in case a financial emergency arises.

Cons

REITs aren’t perfect investments and have some drawbacks. Review the disadvantages of REIT investing to understand how to mitigate the associated risks.

Non-Tax Advantages

There are no tax advantages associated with REITs. Dividends are taxed as ordinary income, so you’ll need to include those returns when calculating your income tax bracket. Additionally, the sale of REIT shares is taxed as capital gains.

Interest Rate Risk

REIT investments are also subject to interest rate risk, which is when the value of an asset could fluctuate as interest rates change. REITs can perform well when interest rates rise, as both are signs of a growing economy. But during a tightening economy, interest rate hikes can make it more expensive to finance properties, leading to a decrease in REITs’ value.

Market Risk

The real estate market is volatile and can be hard to predict. Any downturns in the market, such as falling property values, decreases in rent prices, and less demand, can negatively impact a REIT's performance.

Lack of Control

Once you invest in a REIT, you have no say in what properties the REIT chooses to purchase. This can allow you to earn income passively, but you’ll have no control over how your capital is allocated. REITs have a management team to decide when they want to buy and sell and don’t need to consult their investors before making a decision.

Potentially High Fees

REITs also charge management fees, upfront fees, sourcing fees, and other fees. The types of fees charged and their amounts will vary among REITs, but high fees could reduce your overall returns. Before investing, make sure you review the fee structure.

Where to Invest

Several online platforms make REIT investing easy for beginners. These are just a few of the best platforms for investing in real estate investment trusts:

Are REITs a Good Investment?

REITs, like every asset, have advantages and disadvantages. They are subject to interest rates and market risk, but data shows strong long-term average annual returns. REIT returns may also include dividends, which can allow you to continue to grow your wealth. Plus, they are a good way to diversify your portfolio into the lucrative real estate market. Before investing in any new asset, it’s recommended to consult with an objective financial advisor. They’ll be able to provide detailed, personalized advice on whether a REIT is a good fit for your portfolio.

Frequently Asked Questions