Real estate can be an expensive and difficult asset for an individual to invest in and generate an income on. REITs are a great alternative to traditional property investing and could be a good source of passive income. In this post we’ll explain what a REIT is and how they work. We’ll also look at how anybody can invest in REITs to generate a passive real estate income.
What Is A REIT?
REIT stands for real estate investment trust. It is a type of company that owns or operates income producing real estate.
A REIT can be invested in different types of property and land including both residential and commercial real estate. Some of the property types that a REIT may own include; houses, warehouses, offices, hotels, data centers, factories, shopping malls and more. Most REITs will be focused around one core type of real estate such as office space or warehouses.
Many REITs are traded publicly on stock exchanges and so are easily accessible to an individual investor. They allow ordinary real estate investors the opportunity to own assets that would ordinarily not be easily accessible. As they are traded on a stock exchange they offer more liquidity than investing directly in property.
The main way a REIT makes money is through rental income on the property it owns. Money can also be made on the sale of real estate assets.
There are several conditions a company must meet in order to be classed as a REIT. These will be explained in the next section. One of these is that a REIT must pay out at least 90% of it’s earnings to shareholders as dividends. This usually results in high dividend yields and is an attractive option to earn passive income.
Learn more investment terminology here; A-Z investment and financial terms to know.
How Does A Company Qualify As A REIT?
In order to qualify as a REIT a company must meet some specific conditions. These conditions may vary slightly from country to country but we will focus here on the US. The main conditions are;
- At least 90% of earnings must be distributed to shareholders as dividends.
- Must be a taxable corporation
- No more than 50% of shares can be held by less than five individuals
- Have a minimum of 100 shareholders within a year of forming
- Be managed by a board of directors
- A minimum of 75% of assets must be invested in cash, U.S Treasuries or real estate
- A minimum of 75% of gross income must come from rents, mortgage interest or estate sales.
Types Of REITs
There are three main types of REIT as listed below, each generating real estate income in slightly different ways. These are; equity, mortgage or hybrids.
An equity REIT is the most common type. They own and operate their own real estate with incomes mainly generated through rents on their properties.
A mortgage REIT is different in that they don’t own physical real estate. Instead they hold portfolios of mortgages and mortgage-backed securities. Income is derived from the net interest margin of the mortgages and securities held. Net interest margin is the price difference between the interest income on the mortgage assets and their cost of funding.
The third type of REIT is a hybrid where a company holds a mix of both physical property and mortgages to produce real estate income.
Benefits Of A REIT Over Traditional Real Estate Income
There are many benefits of a REIT over traditional real estate. Firstly, REITs are structured like mutual funds. So all investor’s money is pooled together and used to fund multiple acquisitions which gives great diversification. By holding many properties within the portfolio it mitigates risk from unpaid rents. To achieve the same level of diversification buying traditional property would require a serious amount of capital.
You are also not personally responsible for any of the; buying and selling of property, rent collection, maintenance and any legal or other aspects of owning property.
As REITs are traded on a stock exchange they offer better liquidity over holding physical property. Liquidity is the ability to sell an assert quickly and easily without an adverse loss of value.
One of the biggest attractions to REITs is the regular dividends they offer. Dividend yields are often higher than most other market sectors. These may be paid out on different schedules and will vary by company. Often paid monthly or quarterly, they are a great way to generate passive real estate income.
There are of course a couple of disadvantages to REITs. One of their requirements is to pay out at least 90% of earnings as dividends. This is great for generating income but doesn’t leave much left that can be used to fund new growth.
There are also market and financial risks that come with every investment. In economic downturns some areas of the economy will perform better than others. This could result in tenants defaulting on rental payments or property being hard to sell.
REITs tend to be better suited to those looking for a reliable regular income rather than those seeking capital growth.
Passive Real Estate Income Conclusion
Real Estate can be a great source of passive income mainly generated by rents. There are different ways to invest in property including through REITs which have some advantages over physical property.
To recap, a REIT is the abbreviated term for a real estate investment trust. This is a company that owns and operates income producing real estate or mortgage securities. They can be held privately or traded publicly on a stock exchange. REITs may be traded as individual company shares or as part of a mutual fund or ETF. Invest in REITs with Realty Mogul, the specialist online marketplace for investing in real estate assets.
Did you know you can also invest in real estate for your retirement through a self-directed IRA? Learn more about them in this free eBook guide to self-directed retirement planning.
Benefits of REITs include high dividend yields, regular income payments and good diversification. Additionally they can offer exposure to real estate sectors that are hard to access for ordinary investors. For example – cell phone towers or data centers.
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