Investing

01.15.2021

Everything You Need to Know About Investing in REITs

These tax-advantaged investments should be a part of every investor's portfolio.

investing in REITs

Looking to hedge your yolos with some investments that would make the likes of Warren Buffett and Charlie Munger proud?

We could all use a nice anchor in our portfolio to hedge against volatility.

REITs have consistently ranked among the highest return investments over time, which is why they have been an investor favorite for decades.

Real estate is a historically high-performing investment

4-of-5-wealthy-from-real-estate---buildings

In fact, over the last 30 years across ten different investment classes, REITs have taken the

#1 spot for highest returns eight times – more than any other asset class. For those years that they didn’t snag the #1 spot, they ranked second or third an additional six times.

This year proved to be a rough one for REITs, closing out at a net loss. But smart money knows that a down year can also be a prime entry point. After all, the goal is to buy low, sell high.

For the capitalist who sees the opportunity where others see obstacles, here’s the 360 on all things REIT.

What is a REIT?

REIT is an acronym for Real Estate Investment Trust.

In a nutshell, they are companies that pool investor capital to invest in real estate or real estate products. The gains on these investments are in turn distributed among shareholders.

REITs were defined and passed by Congress in 1960 under the Cigar Excise Tax Extension.

The idea was to give average Americans – who might not have the means to buy more than one property – the opportunity to take part in and enjoy the fairly consistent gains from real estate investments.

The act outlined requirements to qualify as a REIT under law. REITs are incentivized to meet these conditions through tax advantages. The big fish reward is that the company does not have to pay corporate taxes if they meet REIT qualifications.

REIT Qualifications

No corporation wants to pass up tax breaks. They’d rather hit these key numbers than rendezvous with the IRS come springtime:

75%

Percent of total assets invested in real estate, cash or U.S. treasuries. Also the percent requirement of revenue generated from real estate-related income such as mortgage interest rates, rent on property, or profit on real estate sales

90%

Amount of taxable income that is paid out to shareholders – a nice perk for investors, courtesy of Uncle Sam. HappyNest intends to pay out 100% of its net income to shareholders.

50%

The maximum amount of shares that can be held by 5 people or less. Coupled with this requirement is that within the first year of an REITs formation, it must have at least 100 investors in the pool.

3 Trillion

Estimated total value of assets currently held by REITs.

The Benefits Of Investing In REITs

1. Regular returns

Unlike many investments, investing in REITs typically produces regular income in the form of dividends generated from rent or mortgage interest payments.

2. Investing in REITs is accessible to the average person

While it would be great to be in a financial position to buy numerous properties and collect rent monthly, for most people, that’s simply not financially feasible.

REITs offer the ability to participate in real estate investing without having hundreds of thousands of dollars at the ready. With real estate investment apps like HappyNest, for example, investors can buy in with as little as $10.

3. Liquidity

Compared to traditional real estate investment property, buying into and selling out of most REITs is easier and more streamlined and requires a lot less paperwork.

4. Hands-free management

Ask any landlord and they’ll tell you – managing properties is a lot of work. Between filling vacancies, managing tenant requests and complaints, and building maintenance, a lot of time and money can go into the administrative side of real estate.

REITs handle the operational side of real estate investments, so investors can skip the 3 a.m. calls about plumbing issue emergencies.

REIT Taxonomy

Although it may seem difficult to understand all there is to know about investing in REITs, let’s start with the basic building blocks.

Remember in biology class when your teacher covered taxonomy trees? You know, kingdom, phylum, class, order, family, genus, species, etc.?

No? Okay, well, pay attention this time – there’s money on the line.

There are several categories…of categories…of REITs. Very meta, we know.

To make things a bit more digestible, it might help to start with a visualization, then get into the nitty-gritty.

If REITs were a taxonomy hierarchy, they’d look something like this:

REIT Taxonomy

Every REIT has a ‘class,’ ‘order,’ and ‘family’ component.

For example: American Tower Corp is a publicly-traded (class), equity-based (order) REIT that primarily manages telecommunication infrastructure sites (family) around the world.

 

Breaking Down The REIT Taxonomy Hierarchy

Class: Investment acquisition strategy

REITs can be categorized by how they accrue capital for different forms of real estate investing.

They fall into three main categories: Publicly traded, public non-traded, and private.

Publicly traded

Publicly traded REITs trade on stock exchanges like the NYSE. Anyone can buy a slice of a real estate portfolio whenever they want.

Pros Cons
  • High degree of transparency
  • Registered with the SEC
  • Ability to generate a high amount of investment capital quickly
  • Easy to buy and sell (highly liquid)
  • Able to be grouped into ETFs. This means the value of the REIT’s share can be affected by the performance of other REITs and sectors as opposed to solely on the performance of the underlying portfolio.E.g.: If a REIT has a strong year but is grouped with low-performing REITs in ETFs, the REIT’s performance will be adversely impacted.

Public, non-traded

An REIT can be public without being traded on a stock exchange like the NYSE.

HappyNest falls into this category. Though anyone can buy shares of our portfolio of properties, the shares are not listed on the NYSE or anywhere else. We see this as an advantage – and 2020’s bottom lines back us up.

This year, the value of the properties in our portfolio appreciated. But not every sector of the real estate market was quite so lucky.

Had our REIT been publicly traded on exchanges, it’s likely it would have been grouped into other REIT ETFs. Because of this grouping, our returns would have been smaller. It’s the stock market equivalent of “guilty by association.”

Instead, our performance is tied directly to and only influenced by the appreciation of the properties in our portfolio, all of which gained this year.

Pros Cons
  • Registered with the SEC
  • Performance of investment tied to underlying asset value alone – insulated from swings in the market at large
  • Ability to quickly raise capital from investors since anyone can buy in
  • Not bought and sold as quickly (less liquid)
  • Less transparent, harder to tell share value
  • Fees
    *(HappyNest does not charge for broker commission of platform fees)
  • Information provided to the SEC may not be independently verified

Private REITs

Private REITs are not listed on exchanges and not offered to the public. As the name implies – they aren’t open to everyone.

Private REITs are not required to register with nor report to the SEC. More often than not, they are only offered to “accredited” investors, otherwise known as very wealthy people that can take the kinds of financial gambles and hits that would put the rest of us on the streets.

Though private REITs have produced higher returns than publicly traded ones, they come with significant risk. Without an SEC registration, there is little to no oversight on their performance and operations. That makes these kinds of REITs particularly susceptible to fraud.

Management fees can be high and unsubstantiated. Investors must put their full trust into the board of trustees.

Pros Cons
  • Potentially higher returns compared to traded REITs
  • Partially insulated from stock market fluctuations
  • Lack of transparency
  • Must be “accredited” investor
    *net worth of $1 million, not including primary residence or income of $200K+
  • Not registered with the SEC
  • High management fees
  • Can require long holding periods (low liquidity)

Class: Type Of Asset Managed

The ‘class,’ (in our REIT taxonomy hierarchy) is the type of real estate assets managed by that REIT. These primarily fall into two categories:

  • Equity

    An equity ‘class’ REIT owns real estate investment properties. The REIT manages, buys and sells, or collects rent from those properties.

    They generate income and profits via market appreciation of their assets. That could include things like rent payments from properties they own outright or a rent payment that exceeds their own mortgage payment on that property.

    For example: An REIT buys a property for $100,000. Their mortgage payment is $1,500 a month. They are able to rent it out for $2,000 a month. That $500, minus overhead expenses, is profit for the REIT – 90% of which must be paid back to shareholders by law.

  • Mortgage-based

    Mortgage-based REITs provide capital to borrowers much like a bank does. They generated returns via interest paid by the borrower during repayment.

Unlike the ‘order’ (investment acquisition strategy) which is either/or, asset types can be diversified within an REIT.

Two Harbors Investment Corp, for example, engages in both mortgage-backed securities as well as owns a portfolio of properties. Its income is generated by a combination of rent, asset appreciation, and interest paid on mortgages it holds.

Family: Real Estate Sectors

Lastly, within the real estate market, there are sectors.

Examples of real estate sectors include:

  • Residential
  • Commercial
  • Retail
  • Industrial
  • Healthcare facilities
  • Data centers
  • Telecommunications infrastructure

The sector in which a REIT operates can have a huge impact on the bottom line, and the performance of each sector can vary year over year.

A retrospect of 2020 demonstrates just that. As millions of workers across the world were sent to work from home, office buildings and retail storefront worldwide stood empty as leases lapsed and were not renewed.

As a result, office REIT’s year ended with a net loss of almost 20%. Around this time last year, office REIT investors were celebrating 30%+ returns.

Meanwhile, e-commerce demand skyrocketed. In May of this year, even fast shipping MVP Amazon had to remove non-essential items from its 2-day prime delivery schedules.

All that demand meant the need for shipping fulfillment centers, part of the industrial sector, increased significantly. HappyNest has an industrial property in its portfolio, currently leased by shipping logistics company FedEx, that is enjoying this appreciation.

Property-Cards-Gold happynest properties in ints real estate investing portfolios
Properties in HappyNest’s real estate investing portfolio

Choosing The Right REIT For Your Investment

At the end of the day, every investor wants to protect the value of their investment and gain a little alpha along the way.

Though 2020 wasn’t the best year for REITs as a whole, some sectors thrived. Even for those that didn’t, as the old saying goes: Buy low, sell high. The dip in performance could prove to be a great entry point. REITs have historically outperformed stocks and other asset classes consistently.

Successful REIT investments are often the product of accurate predictions of what comes next.

HappyNest remains confident in its portfolio of properties’ ability to weather – and even thrive – in the upcoming year. Are you ready to start investing in REITs?