Real estate has always been a popular investment vehicle for both growth and income. Historically, real estate investors were limited to directly buying real estate, managing the properties and collecting rental income. In 1960 this changed when the US Congress passed an amendment to the Cigar Excise Tax Extension establishing REITs (real estate investment trusts). So, what are real estate investment trusts (also known as “REITs”)?

What are Real Estate Investment Trusts?

Real estate investment trusts open the door to individual retail investors to be able to buy shares in commercial real estate portfolios and receive income from these investments. These portfolios could include different types of real estate including commercial real estate, industrial properties, multifamily properties (think apartment complexes), healthcare facilities (hospitals, assisted living, nursing homes), office buildings, retail, malls, self-storage, infrastructure and even hotels.

This is how it works. Investors purchase shares of REITs (like stocks) and receive rent on the properties owned in the REIT portfolio in the form of dividends. Some REITs actually pay monthly (Realty Income is an example, having trademarked “The Monthly Dividend Company”) further increasing the similarity of this real estate stock based investment with actual direct real estate investment performance (i.e. getting your monthly rent check from your properties).

Different types of Real Estate Investment Trusts

In addition to answering “what are real estate investment trusts”, you also need to understand the different types of REITs. REITs can be categorized several ways:

REIT Property Specialty

This category primarily divides the different REITs by the type of property (ie commercial, industrial, multifamily, healthcare facilities, office buildings, retail, malls, self-storage, infrastructure and hotels) the REIT holds in its portfolio.

REIT Capital Allocation Type

REITs can be also categorized by how they use their capital. Some REITs purchase and manage properties directly (Equity REITs), some REITs actually lend money to real estate owners versus owning the properties directly (Mortgage REITs) and other REITs combine the two approaches (Hybrid REITs).

REIT Offering Types

REITs can also be further categorized by how shares are offered to the public. There are publicly traded REITs (registered with the SEC and trade on stock exchanges), SEC registered non-traded REITs, and Private REITs (not registered with the SEC).

Why Did the Creation of Real Estate Investment Trusts Revolutionize Real Estate Investing?

The creation of REITs in 1960 revolutionized real estate investing for individuals as it allowed retail investors to participate in large real estate projects the same way stock investors were able to own small parts of large corporations. You were finally able to buy into multimillion dollar real estate ventures one share at a time.

Instead of placing all of your money into one real estate deal, say purchasing a duplex, you could spread it out among several properties, reducing your risk and getting you access for substantially less capital. I have found that REIT yields have exceeded direct investing returns in some scenarios.

REIT and Investing Educational Resources

This article is just a general overview into what real estate investment trusts are. There are many sources of online information that go into much greater detail about REITs, their legal requirements, operations and other factors.

Investopedia is a great source of free information on real estate investment trusts and investing in general and is one of my “go to” learning tools. Here is a link to Investing 101 – A Tutorial for Beginner Investors – a great free resource to get you started. Investopedia’s Academy Courses are also a great tool for advanced investing learning. They are comprehensive courses and are taught by seasoned professionals.

General Thoughts on Real Estate Investment Trusts

Investing in REITs is a powerful income lever due to their liquidity, simplicity and higher return versus direct real estate investments.

I invest in publicly traded REITs due to the transparency requirements (SEC registration and requirement for reporting), lower fees, and liquidity. I do avoid private REITs due to their illiquidity and history of high fees and lower return.

Internal versus External Management

Additionally, when I invest in REITs, I look for internally managed REITs (management is internal to the company) versus REITs that are externally managed to reduce conflicts of interests with the management company.

Volatility in REIT and Stock Investments

A word about volatility of REIT investing versus direct real estate investments. One of the negatives of any stock investment is the constant price action. The price of the stock or REIT investment is constantly fluctuating up and down with the stock market. These fluctuations heighten the sense of unease and fear of “losing everything” in the stock market.

It is important to remember that stock market price action is similar as someone shouting prices at you as they drive by one of your commercial properties. This comparison sounds silly, but it is in fact the same thing. You wouldn't sell your building this way. If you had to quickly dump a building, it would generate much higher losses due to the liquidity factor.

I value my REIT investing business (my REIT income lever) just in the same way as my direct real estate investing businesses, by the cash flow. If you have a high quality business that is paying you a great return, there is no reason to sell.