REIT Investing

A Complete Guide by the hartman companies

REIT investing has historically proven to be a powerful, high-yield strategy for ambitious inventors.

This guide has been assembled by the team at The Hartman Companies, which grew out of Al Hartman’s early investment efforts in the Dallas, Houston, and San Antonio, Texas markets. The company and group have evolved, establishing a significant presence in the area. This guide will help you better understand the dynamics around REIT investing.

How Do You Make Money with REIT Investing?
How Do REITs Pay Investors?
How to Find REITs to Invest in?
How to Assess a REIT Before Investing
How Much of Your Portfolio Should You Allocate to REIT Investing?
Disclaimers Regarding REIT Investing
The Hartman Companies REITs

What is a REIT?

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate and selects special tax treatment that exempts it from federal income taxes on its corporate income and gains that it distributes to its investors.

What is REIT Investing?

Modeled after mutual funds, REITs function by pooling capital from numerous investors, making it possible for individual investors to earn dividends from real estate investments, all without having to buy, manage, or finance any properties themselves.

Why Invest in a REIT?

1. Historically, REITS have produced competitive total returns due to steady dividend income and long-term appreciation.

2. REITs can lower overall portfolio risk, as they diversify portfolios and offer a low correlation with other assets.

3. REITs make it possible for anyone to invest in real estate, not just high net worth individuals.

REITs Pros and Cons

REITs can play an integral role in a balanced investment portfolio because they can offer a strong, stable annual dividend and the potential for long-term capital appreciation. Like any investment however, REITs have both advantages and disadvantages.

PROS:

Hedge against inflation – REITs are typically exempt from market fluctuations felt through stock investments. Additionally, since real estate is known for success over the long-term due to competitive long-term performance and high-yield dividends, REITs are typically a successful hedge against inflation.
Transparent corporate structures – While private real estate investment groups are known for little oversight, REIT investments are very transparent. REITs must operate using analysts, auditors, independent directors, and financial media to fully monitor its performance. Additionally, REITs (when publicly registered) are required to report financial results to the SEC, adding to investor stability and protection.
Competitive Long-term performance – Historically, REITs have performed competitively, or even better than, stocks, especially over the long-term. In the last 40 years, REITS out-performed bonds in every historical period. Performance is not guaranteed: past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections are not guaranteed and may not reflect actual future performance.
Attractive passive income – Because a REIT is required to distribute 90% of their REIT taxable income to remain compliant with IRS regulations, REITs generate solid total returns. In 2021, the average REIT had a yield of over 3% which is very good considering that is twice the average dividend of stocks in the S&P 500.
Diversification of your portfolio – REITs are a great way to diversify and lower the risk of your overall portfolio, without the volatility of stocks and other private real estate investments. REITs are also protected from market fluctuations due to low correlations with stocks.
High-yield dividends – REITs are known for high dividend payouts. Dividend yields tend to be above-average due to a requirement that 90% of their taxable income is paid to shareholders.
Potential for good returns – Because real estate values typically increase with time, REITS offer good return potential. REITs use strategies to increase value such as buying low occupancy properties and adding value through renovation, including adding new amenities and updates.
Liquidity (only for publicly traded reits) – Unlike typical real estate investments which are not easily liquified, public REITs off liquidity events over time. REIT investors also avoid broker’s commissions typically present in the sale of traditional real estate investments.
Access to commercial real estate investing – REITs offer an opportunity to invest in commercial real estate that is often unattainable for individuals on their own. Through REITs, individuals can put their money into commercial real estate assets by owning a small piece of a shopping center, office building, warehouse, or other commercial property.
Tangible investment – REITs remove acquisition barriers and the headaches of property ownership and management by offering a tangible way for individuals to invest in commercial real estate.

CONS:

Dividends taxed as ordinary income – Typically profits on long-term (one year or more) investments are taxed at the lower capital gains tax rate. However, REIT dividends are taxed at the investors standard income tax rate, which is higher.
Sensitivity to interest rates – Market conditions such as rising interest rates can affect the profitability of REITs. As interest rates rise, profit margins can lower, negatively affecting dividend payouts.
Risks associated with specific properties / tenants of properties – Like any real estate investment, it’s important to do your own due diligence on property values, debt, geography, interest rates and tax laws, as they can affect the risk of the investment.
Potential high fees – REITs are sometimes subject to high transaction and management fees from property acquisitions and properties under management. Understandably, these fees often do not align with shareholder interests.
Not a short-term (less than 3-5 years) strategy – Because 90% of profits are paid out as dividends, REITs are often left with little principle to grow investments. Therefore, REITs can experience slow growth and should be considered a long-term investment.
No control over performance or returns – Unlike private real estate investors who have control over sweat equity and selecting high income-earning properties, REIT investors have little control over the real estate investments, as the REIT company controls most decisions regarding the property.

How to Invest in a REIT?

You can invest in REITs by buying stocks or shares in either a publicly traded or privately purchased REIT. Whether a REIT is publicly or privately traded is an extremely important distinction when investing in order to understand the associated risks and benefits.

Publicly traded REITs are registered with the SEC and publicly traded on a stock exchange.

Non-traded Public REITs are registered with the SEC, but are not traded on a stock exchange. They are typically sold by a broker or financial adviser. Non-traded REITs generally have high up-front fees. Typically, sales commissions and start up fees can total up to ten percent of the investment.

While REITs can be traded publicly, not all REITs are. This makes them more difficult to invest in, and can require investors to make a more substantial investment.

Private REITs are funds and companies are exempt from SEC registration. Meaning private REITs include shares that do not trade on the national stock exchange. Typically, private REITs must be bought through your financial advisor at a brokerage. Investors should check with a financial advisor to see if they qualify as an accredited investor.

Types of REIT Assets

Different REITs will own different real estate assets, each of which come with various benefits and considerations. Depending on the type of REIT assets, investors may experience varying risks and ROI’s. For instance, REITs can include office space, retail space, or flex space, as examples, or combinations of different assets. Let’s review the defining features of the different types of REIT investments.

Retail REITs – Retail REITs are companies that acquire, develop, lease and manage any type of retail location (outlet mall, shopping center, etc.). Favorable lease agreements typically include annual rent escalations and triple net leases. Negatives of Retail REITs can include the strong shift to online shopping and declining foot traffic to support retail centers.
Residential REITs – Residential REITs are companies that acquire multi-family homes, manufactured dwellings, apartments, or student housing. Residential REITs are typically very successful in areas experiencing population and economic growth, but highly affected by the volatility of interest rates and economic policy.
Industrial REITs – Industrial REITs typically refer to industrial warehouses or distribution centers. Benefits of industrial REITs include long-term lease terms, triple net leases (tenant is responsible for operating expenses), and the overall growing demand of e-commerce. On the flip side, industrial REITs can be risky as they rely on the health of a global economic market.
Healthcare REITs – Healthcare REITs refer to companies acquiring and managing hospitals, nursing homes, and assisted living facilities. There is a high demand for these due to an aging American population and ever-growing demand for these types of facilities. However, the healthcare industry can provide uncertainty as it is subject to changes in public policy.
Office REITs – Companies acquiring and managing office locations are referred to as office REITs. Office REITs are typically characterized by longer leases than industrial properties, but office space is highly affected by economic growth and stagnation.
Lodging/Hotel/Resort REITs – Companies acquiring and managing real estate in the hospitality industry, for example hotels and resort properties, are referred to as hotel/resort REITs. These perform well when the economy is strong. On the other hand, hospitality type REITs are very negatively affected when the market is down.

Types of REITs to Invest in REIT Sectors

REITs are classified in sectors which denotes the makeup of their properties, how they are traded, and what sectors they represent.

Equity REITs
Equity REITs are trusts that generate income from renting real estate to tenants. Income is distributed to investors through dividends after paying property management fees and other expenses of operation.
Mortgage REITs
With mortgage REITs, income is generated from interest on mortgages. Because investors are able to collect interest paid on mortgages as income, mortgage REITs are popular for their high interest payment pay outs on commercial mortgages.
Public REITs
Publicly registered/privately non-traded traded – Publicly registered and privately traded REITs are called public non-listed REITs. This means they are registered with the SEC but do not trade on the national stock exchange.
Publicly registered/publicly traded – Publicly registered and publicly traded REITs means the REIT is both registered with the SEC, and publicly traded on the national stock exchange. Theses REITs are marked by high liquidity because they can be sold or traded at any time.
Private REITs
Private REITs are real estate funds or companies that do not trade shares on the national stock exchange, and therefore are exempt from SEC registration. For this reason, they can only be sold to institutional investors.
Hybrid REITs
For individuals looking for portfolio diversity, hybrid REITs are comprised of both equity and mortgage holdings. For both a more growth-oriented or income-oriented portfolio, hybrid REITs can provide better protection from market fluctuations.

How Do You Make Money With REIT Investing?

REIT investing involves a company buying real estate, leasing space in those assets, and then collecting rent. Rents generate income, and that income is then paid to shareholders and investors through dividends. Shareholders can also experience stock growth, where the value of their stock rises based on the value of the properties that make up the REIT. To be successful, a REITs goal is to build value through growing and buying cash-flowing assets, or by selling assets. Investors benefit financially from increasing rents and also occasionally the proceeds of a property sale. Publicly-traded REITs are easily accessible to investors as they can buy, sell or trade online, similar to how they would a stock. On the other hand, privately traded REITs must be brokered through an accredited investor or registered broker. To find success with REIT investments, it’s important to consider how a REIT investment fits into your existing investment portfolio.

How Do REITs Pay Investors?

All REITs are required to payout at least 90% of their net earning to shareholders through dividends. Therefore, regardless of the specific type of REIT, they always pay dividends to investors. Dividends consist of rental income, capital gains, and any other earnings such as profits from the sale of a property. Dividend payouts are relative to the success of the REIT–if there is no profit, shareholders do not make anything on their dividends.

How to Find REITs to Invest in?

There are two main ways to begin investing in REITs. First, find a REIT directory or list of REIT funds online and begin your research. Second, contact a financial advisor to assist in the purchasing of stocks or shares through a broker. To avoid buying individual REIT stocks, investors can consider a mutual fund that vets and invests in a range of REITs on the investor’s behalf. The benefits are greater diversification. Typically, a brokerage offers the option to invest in mutual funds, which can be less manual work than individual REIT investment.

How to Assess a REIT Before Investing

Investing in a REIT means investing in an entire portfolio of income-producing real estate or mortgages, or a hybrid of both. To perform proper due diligence, it’s important to consider a number of key factors to assess the viability of a REIT investment.

1. Review the REITs portfolio of properties.

This should include review of existing tenants, lease terms, rent collection timelines, acquisitions, and dispositions. Pay special consideration to the business health of existing tenants, length of leases, history of rent collection, and whether the REIT’s portfolio is growing or declining.

2. Review the valuation of the shares/stocks.

Pay close attention to FFO (funds from operation), Price to FFO, AFFO (adjusted funds from operation, and NAV (net asset value) in order to paint a complete picture of true earnings.

Review the firm’s dividends. Rather than just review the REITs current dividend yield, investors should consider the history of dividend yield (average over a selected period of time) and the payout ratio, which will help to understand whether current dividend growth is sustainable or not.
Review the firm’s debt structure. This includes review of EBITDA (earnings before interest, tax, depreciation and amortization), debt maturity schedule, interest rates and debt costs.
Review the REITs personnel and management. As with any company, a REITs management team is key to the future success of the company. Reviewing the status of the CEO, CFO and COO will tell the story of how the company operates and how it manages its real estate portfolio.

In addition to the above research, consider two additional points of precaution. First, evaluate the liquidity of the investment depending on the type of REIT sector. Second, investors should consider the ability to reinvest dividends. Understand whether it is possible to start with a smaller investment and build up to larger dividends.

While some investors may choose to perform their own due diligence, it is helpful to remember that Brokerage firms have analysts who perform this specific due diligence on a daily basis and have years of practice reviewing REITs for investment. It is wise to work with a qualified financial planner versus researching and investing solo.

How Much of Your Portfolio Should You Allocate to REIT Investing?

REIT investing is a cornerstone of a diversified portfolio. So, how much of a portfolio should be specifically allocated to REIT investing? To answer this question, let’s first take a look at the Yale Endowment Method. Yale’s endowment is notorious for being well-diversified and equity-oriented. A lot can be learned from how the Yale endowment allocates its investments. With a 9.5% investment in real estate within an investment portfolio, the goal of the Yale Endowment Method is to lower risk and raise return, while protecting investors against inflation. Because REITs are an illiquid investment, investors are locked in, removing the temptation of reactive selling during market down periods. David Swensen, creator of the Yale Endowment Method, crafted a specific portfolio for individual investors based on his model. Referred to as the Swensen Portfolio, the asset allocation includes 20% to REITs. For individuals looking to invest using this model, always consult your financial advisor first.

Disclaimers Regarding REIT Investing / Conclusion

While REIT investing can be a solid investment strategy, it does come with associated risks. Risk is inherent in any investment with notable upside — not just REIT investing. Still, here are the risks to consider before beginning REIT investing:

A decrease in demand for office, industrial, or retail space can adversely affect the income potential of REIT dividends.
Lack of illiquidity. Assets tied up in REIT investing are more difficult to liquify if liquidity becomes an immediate need.
Economic and regulatory changes can impact the real estate market, which can cause the value of investments to decrease.
S. and global market conditions may adversely affect the financial conditions of tenants.
Government regulations may affect tenant renovations or operations subject to such regulations.
Properties within a REIT may experience vacancies which would affect dividend payouts to rent loss, or lower the value of a potential property sale.

Considering the risks of an investment is a valuable step in the due diligence process. While risks are present, there is also considerable upside to REIT investing. REITs offer great portfolio diversification, competitive total returns, and the opportunity for attainable entry into the real estate investing world. To grow and diversify your investment portfolio, reach out to a financial advisor to consider REIT investing.

The Hartman Companies REITs

The Hartman Companies operate multiple REIT funds throughout Texas. We provide our tenants exceptional service based on inspired values, which enriches their experience and builds a strong value chain.

To learn more about our company, visit our About the Firm page.