Posted by Michelson Law Office

Pros and Cons of Investing in REITs

Pros and Cons of Investing in REITs

Types of Real Estate Investing

The following are the most common ways persons invest in real estate 

Home Ownership

Buying a house means you are at some level investing in real estate. But a difference lies between investing in other real estate property and owning your own home. When you own your home, you will not regularly make money or increase the cash flow of the property monthly. 

Rental Properties

Possessing a property that you rent out is another way of real estate investing.

The advantage of this is that income generated becomes an added stream of revenue, which can be utilized for retirement. It could ensure you make thousands of dollars yearly. Then, if the property is sold, you could also earn a huge profit if the property has increased in value. Renting out anything from a bedroom to a whole house to a commercial property like an apartment building is possible

House Flipping

In the year 2017 alone, over 200,000 single-family homes and condos were flipped. Flipping a house means the house is purchased, renovated, and sold, and this is done within a short amount of time. In most cases, the key to flipping a home is to buy low; a considerable profit is not feasible unless the property is purchased at a low price.

House flipping is considered appealing because it is a faster process when compared to renting a property for years. Within a few months, the property could be back on the market, and huge profit expected to be made from sales. Just like every other investment, there is a risk of not making any profit from the sale and even can be incurred.

The disadvantage of house flipping is that it may cost more than expected in renovating the house, and this may eat into the expected profit. Flipping a home takes a lot of time, energy, and even resources, so one must carefully consider it before taking the steps required. It is wise to consult a real estate professional before venturing.

REITs

Real estate investment trusts (REITs) are considered a less conventional way to invest in real estate. REITs are companies or trusts that own or finance real estate investments, and they sell shares to investors with the hope of receiving a percentage of the income made off that real estate investment.

Pros and Cons of Investing in REITs

REITs can be vital in an investment portfolio. Just as other investments, they have their merits and demerits

On the merit side, REITs are less challenging to buy and sell, as most trade on public exchanges. This marketable feature lessens some of the known drawbacks of real estate. Traditionally, real estate is notoriously known as a property that takes a long time to sell or purchase—and its lack of transparency as reliable information on taxes as not offered on all markets, ownership, and zoning. REITs are controlled by the SEC and must file audited financial reports.

Performance-wise, REITs give attractive risk-adjusted returns and stable cash flow. Also, a real estate presence can be useful for a portfolio, diversifying it with a different asset class that can stand as a counterbalance to bonds or equities.

REITs do not give much in terms of capital appreciation on the downsides. As part of their structure, they are required to pay 90% of income back to investors. Hence can only reinvest 10% of the taxable income for the purchase of novel holdings. 

Dividends gotten from REIT holdings are taxed as regular income. A significant risk for REITs is that real-estate market fluctuations influence them. Like most investments, they don’t guarantee a profit or ensure against losses. Further, some REITs have high transaction and management fees.

How to Invest in REITs

Investment can be made in publicly traded REITs likewise REIT mutual funds and REIT exchange-traded funds (ETFs) via purchasing shares via a broker. You can purchase shares of a non-traded REIT through a broker or financial advisor who is involved in the non-traded REIT’s offering. REITs are also part of a growing number of defined-benefit and defined-contribution employer-sponsored retirement and investment plans.

Ensure you consider the REIT’s management team and their track record and find out how they compensate. If it is performance-based compensation, there is a high possibility they will be working hard to pick the right properties and make the right choices of the best strategies. Considering the numbers is a good idea, like the anticipated earnings growth per share (EPS) and current dividend yields. A particularly important metric is the REIT’s funds from operations (FFO), which calculates the cash flow generated by the REIT's assets.

Real World Example of a REIT

Considering what sectors of the real estate market are hot is another consideration when choosing a REITs. Consider the booming area of the economy that can be tapped into through real estate. For example, health care is one of the fastest-growing industries in the U.S.—especially in the rise of medical buildings, elder care facilities, and retirement communities and outpatient care centers.

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