If you’d like to invest in real estate but don’t have the resources, time, or expertise to buy and manage properties yourself, then real estate investment trusts (REITs) could be alternatives to consider. With a REIT, you buy into a professionally managed real estate portfolio, which has been created by pooling money from many investors.
What is a REIT?
REITs are companies that own, operate, or finance real estate—like apartment buildings, shopping centers, offices, data centers, and more—but in many cases with shares that trade on exchanges, like stock.1 When you buy a stock, you become a partial owner in the underlying company. Similarly, when you buy a share of a REIT, you become a partial owner of the REIT’s underlying properties.
Additionally, they offer a way to put real estate investing within reach of ordinary people.
How does a REIT work?
A REIT raises money from many individual investors, and uses that money to build and manage a portfolio of real estate investments. This could mean buying properties to lease to tenants or invest in financial assets like mortgages. The REIT collects rent from its tenants or receives payments on the mortgages it holds, and it generally distributes its earnings to shareholders.
To qualify as a REIT, a company must meet certain requirements and follow certain rules. A REIT must generally invest at least 75% of its assets in real estate and pay out at least 90% of its taxable income annually to shareholders as dividends. In exchange for following those rules, REITs get special tax treatment that may allow them to pay little or no corporate income tax2 (though REIT investors still generally owe taxes on any dividends and realized gains).
Because of their focus on paying out relatively high ongoing dividends, REITs are often popular among investors who seek to earn steady income from their investments. However, it’s important to be aware that dividends aren’t guaranteed, and a REIT can always reduce its dividend payments.
Types of REITs
There are several different ways of categorizing REITs.
Equity: Buy and operate properties—leasing them out to tenants and collecting the rent. Equity REITs can specialize in particular niches of the real estate market, like warehouses, infrastructure, data centers, and more.
Mortgage: Use investor funds to finance mortgages—collecting mortgage payments from borrowers and earning income via interest. Mortgage REITs could also buy mortgage-backed securities.
Hybrid: Invest in a mix of real estate properties and mortgages.
Another type is by market such as classified as publicly traded, public non-traded, or private REITS.
Publicly traded: Regulated by the Securities and Exchange Commission (SEC) and are listed on major stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq. It's generally easy to buy and sell these REITs, and to look up key information about the companies.
Public non-traded: Regulated by the SEC, but do not trade on major exchanges. Non-traded REITs can generally only be purchased through certain brokers, and they can be more difficult to sell.
Private: Not regulated by the SEC and does not trade on major exchanges. Generally, only institutions and high-net-worth investors can invest in private REITs.
Most often, when people talk about “investing in REITs,” they’re really referring investing in publicly traded REITs.
Potential advantages of publicly traded REITs
Publicly traded REITs can come with a number of potential advantages:
Low initial investment: It’s possible to become a real estate investor for the cost of just one share. If you invest with a broker that offers fractional shares, then you may even be able to start with as little as $1, which is more achievable for many investors than buying an entire property.
Access to cash if you need it: Investors can buy and sell publicly traded REITs whenever markets are open. While you aren’t guaranteed to get your money back if you sell, you can quickly turn the value of your investment back into cash.
Potential to earn ongoing income: Due to their structure and the requirement to pay out 90% of taxable income, REITs tend to be popular among investors looking to generate income from their investments.
Potential diversification: REITs have different characteristics and attributes from traditional stocks and bonds. They may also perform well or poorly at different times in comparison to other investments. To add, they might help provide diversification to a portfolio—or avoid placing all your eggs into the same basket. Diversification; however, does not ensure a profit or guarantee against loss.
Potential disadvantages of publicly traded REITs
Publicly traded REITs also come with a number of potential drawbacks:
Require research: If you’re going to invest in individual REITs, you need to do some work to understand them and choose specific investments.
Tax rate on dividends: REIT investors generally owe tax on the dividends they receive, and these dividends are typically taxed at higher ordinary income tax rates, rather than at lower qualified dividend tax rates.3 Holding REITs in a tax-advantaged account may allow investors to defer these taxes.
Subject to potential market volatility: Because REITs trade on exchanges like stocks, they can be subject to market fluctuations in the same way.
Come with unique risks: There is no guarantee that issuers of a REITs will maintain the secondary market for its shares, and redemptions may be at a price that is more or less than the original price paid. Changes in real estate values or economic downturns can have a significant negative effect on issuers in the real estate industry.
How to invest in REITs
Investors can buy publicly traded REITs the same way they buy stocks. In a brokerage account, an investor can place an order for an individual publicly traded REIT using its ticker symbol.
Another option is to buy one or more mutual funds or ETFs that hold REITs. Mutual funds and ETFs are professionally managed portfolios that combine your money with that of other investors and invest it in a basket of securities. They can offer a way to invest in a diversified, professionally managed portfolio of REITs without having to research a lot of individual REITs.
To learn more about simple tips on how to get started investing in real estate, visit Fidelity Viewpoints: 4 ways to invest in real estate.
Should you buy REITs?
Some considerations to help you decide whether REITs work for your portfolio:
Your investing goal: The first step in building a portfolio is generally to decide on your investing goal—retirement, or a child’s college education, or something else. Once you understand your goal, you can also begin to direct your attention to an appropriate investment mix and consider whether REITs might make sense as part of that mix. (Fidelity customers can get an investment strategy for their goals at the Planning and Guidance Center.)
Diversification: If you already own a home, your net worth may already be significantly exposed to real estate. You may also already have exposure to REITs if you own a broadly diversified portfolio, or invest in a broadly diversified fund like a target-date fund. Conversely, if you don’t own a home or REITs, then adding some to your portfolio might help give you exposure to real estate and provide diversification.
Risk tolerance and need for liquidity: REITs can have the potential to generate relatively high income but they are not guaranteed investments, and it is possible to lose money. Publicly traded REITs are generally liquid—meaning you can quickly sell your investment and convert its value into cash—but the price at which you can sell is subject to market fluctuations and is never guaranteed.
There are no “best” investments—only tradeoffs to consider in relation to your situation. For many investors, it may make sense for REITs to have some role in a broadly diversified portfolio.