What is a REIT?

If you’re interested in investing in real estate but don’t think you have the financial means to make that move, you may have an option.

A REIT, or real-estate investment trust, is a company that owns, operates or finances income-producing real estate. Most REITs trade on a public exchange, so any investor can purchase shares.

REITs make it easy for anybody to invest in real estate. You don’t have to purchase your own rental property or office building to benefit from a real-estate investment; you can simply purchase shares in a REIT, REIT mutual fund or exchange traded fund (ETF).

What types of real estate do REITs include?

A REIT portfolio can include a wide range of real-estate properties. That might include apartment complexes, hotels, healthcare facilities, data centers, office buildings, retail centers, timberland (land covered with forest/trees—not the boots brand) and warehouses. It can also encompass infrastructure such as fiber cables, cell towers and energy pipelines, or a collection of mortgages on real-estate properties. Many REITs focus on a particular type of real estate, but some include a variety.

There are three basic types of REITs, based on the types of real estate they hold. The most common is an equity REIT, which buys, owns and manages income-producing real estate. An equity REIT makes money by collecting rent rather than reselling its properties.

A mortgage REIT, or mREIT, lends money to those who own or operate real estate. That could be through mortgages, loans or mortgage-backed securities. These REITs earn revenue from collecting interest payments—so their performance can be sensitive to interest rate changes.

Finally, a hybrid REIT holds both physical rental property and mortgage loans in its portfolio, so its earnings come from both rents and interest on loans.

How do you invest in a REIT?

You can invest in a REIT the same way you can invest in any public stock, mutual fund or ETF. You just purchase shares in a REIT or a REIT fund on the stock exchange. A broker or financial planner can help by recommending REIT investments, and REITs are often included in robo-advisors’ recommendations.

Some REITs are private, while others are public but not listed on a stock exchange. However, these are still available for investing.

How do investors make money from a REIT?

Most income-producing real estate earns money by collecting rent or mortgage payments. For instance, If you bought a home to lease out as an investment, your profits would be the rent you collected each month, minus your expenses on the home.

With a REIT, investors make money the same way, but they don’t have to take on as much risk. Rather than outlaying (or borrowing) the cash to purchase a rental property, you can simply purchase shares in a REIT and get a portion of the rent income. (And you won’t get a phone call when the pipes freeze or the roof leaks.)

And the payoffs can be generous: REITs are required to return a minimum of 90 percent of their taxable income in the form of dividends to shareholders each year.

How do you choose a good REIT to invest in?

Choosing a REIT is a lot like choosing a mutual fund or other investment. First, it’s wise to look at how the REIT is managed. Check the track record of the REIT’s management team, and find out how they are compensated. If their compensation is based on performance, they are likely to keep in mind the best interests of investors.

Also, look for a REIT that has diverse holdings. Any investment portfolio can hedge against risks by being diversified, and the same is true for REITs. If the REIT contains various types of property or properties in different locations, it can still maintain strong returns even if one type of property suffers losses.

Finally, look at a REIT’s earnings before choosing to invest in it. The REIT’s funds from operations and cash available for distribution measure its overall performance, allowing you to gauge how much money is being paid out to investors.

Are REITs a new way of investing in real estate?

No, REITs have actually been around for more than half a century. The U.S. Congress established them in 1960 to allow individual investors to purchase shares in commercial real-estate portfolios that receive income from a variety of properties.

But companies must meet certain criteria to qualify as a REIT. For instance, a REIT must invest at least 75 percent of its total assets in real estate, cash or U.S. Treasury bonds. It must also receive at least 75 percent of its gross income from property rents, interest on mortgages financing real estate, or from the sales of real estate.

After its first year of existence, a REIT must have at least 100 shareholders. And, as mentioned earlier, it must return a minimum of 90 percent of its taxable income in the form of dividends to shareholders each year.

If you want an affordable, hassle-free way to invest in real estate, investing in a REIT may just be the answer.