Earlier this week, MyNOI covered what a real estate investment trust (REIT) is and how you could get involved in them. While REITs offer a great way for skittish first-time investors to try their hand at commercial real estate, there are some drawbacks to them as well. Today, we’ll cover both the good and the bad of REITs.
Advantages of a REIT
REITs are required to pay out 90% of their income as dividends
By law, REITs must pay out a significant majority of their profits as dividends to shareholders. (That’s you!) This requirement means your REIT investment will offer you stable returns, safe from any meddling trust managers.
The stock market and the housing market are not tied together tightly at the hip. While the ‘08 recession saw them both tank, it’s possible for the sectors to move in opposite directions. Investing in a REIT helps protect your income in case your publicly traded stocks aren’t doing well.
From the real estate side, REITs also offer a diversification of property. The pooling money means your trust is able to purchase much more land than if you went it alone. This allows you to be a part of industrial properties, retail stores, multifamily units and more, so a slump in one sector doesn’t hurt your income as bad as it could.
Hassle free commercial real estate
Some investors find the micromanagement of their buildings to be an exciting part of ownership. For those who find it to be an absolute grind, REITs offer a chance to own real estate without all the nitty gritty of managing it.
It is much easier to sell your stocks in a REIT than it is to sell a physical building. If you feel like getting out, you simply sell your shares to a someone interested in purchasing. Compare that with the option of paying property taxes for months while buyers tour your commercial building.
Disadvantages of a REIT
Tied to the real estate market
An obvious disadvantage to REITs are their tether to the real estate market. Rising vacancy rates, lower rent prices and other variables will all affect the success of your REIT investment. Your dividends are not guaranteed, meaning any hit to the real estate market will be a blow to your pockets as well.
Distributing 90% of income is great for investors, but it also mean the trust only has 10% to reinvest. The relatively small amount left over makes it difficult for REITs to grow without forcing managers to take on debt.
High tax rate
Most dividends are taxed at a friendly 15%; this is not the case for money made on REITs. The government classifies REIT dividends as regular income, which can carry a much higher tax rate.
Lack of control
While passive income can be pleasant, you’re ceding direct control over how your properties are handled. Trust managers may make decisions concerning your commercial property you disagree with. And if a downturn happens, you can’t personally take any actions to protect your investment.
Check back on Friday to learn more about the history behind REITs.