Establishing a well-rounded investment plan is a lot like putting together a balanced meal. Like a healthy plate full of grains, greens, fruits, and protein, an investment strategy with a little bit of everything means an investor won’t miss out on any food group.

Even though a diversified portfolio can’t eliminate risks completely, it can help reduce them. The idea of diversification is much like not putting all of your eggs in a single basket.

Speaking of having a variety of investment options, Real Estate Investment Trusts (REITs) are becoming more popular nowadays. REITs can be thought of as just one part of a well-balanced investment plan. 

As with any investment, too much of one thing could mean too much risk and not enough variety. On the other hand, if you completely ignore a type of investment, you might miss out on future earnings.

So, what are REITs, and what makes them a good (or bad) investment? In this article, we’ll be focusing on the advantages and disadvantages of investing in REITs. 

What Exactly Is A REIT?

REITs are companies whose sole purpose is to own and operate real estate. Some invest in commercial real estates, such as parking lots or office buildings. Others invest in residential real estates, such as apartment buildings or houses.

Most companies distribute them to their investors on a quarterly basis, making them an excellent interest-earning vehicle for retirees looking for a consistent stream of income.

Unlike publicly traded companies, REITs frequently distribute 100%of their taxable income as dividends, avoiding corporate income taxes. Profits are distributed to investors pre-tax after management deductions. REITs have outperformed corporate bonds in the long run, making them more appealing to risk-averse investors.

PROs Of Investing In REITs

Why do a lot of investors go for REITs? Investing in REITs has a number of advantages including the following: 

1. Diversification 

Once you start investing in REITs, you can spread out your investments. Instead of only investing in bonds and stocks, you can invest in real estate and get high returns without the risk and volatility of stocks. Also, real estate and stocks go hand in hand, protecting your investment from market changes.

As an investor, you can quickly diversify in the real estate market by having a stake in several properties in different sectors. Investors may take a small amount of money and put it into several different kinds of properties, such as industrial warehouses, commercial properties, and apartment complexes. Most of the time, big properties like hotels or office buildings that some investors can’t get to are part of these funds.

You can also invest in different places with REITs. They let you buy a share of a property in many different states, cities, and countries. Foreign investors often can’t own property in another country, but REITs make it possible for them to do so.

2. High Yields

Given that a REIT is mandated to pay at least 90% of its taxable income to its shareholders, its dividend yields are usually higher than average. It’s not unusual for REITs to have a safe dividend yield of 5% or more, while the average stock yields less than 2%. 

So, there’s no doubt that investing in REITs can be an excellent choice for people who want to reinvest their dividends or need income while letting their gains grow over time.

3. Profitability

One of the best things about REITs is that they have a high chance of giving you good returns. This is especially true if the value of the assets they are based on goes up. Long-term, the value of real estate tends to go up, and REITs may use some strategies to add more value. To make the most of their money, they could build new properties from scratch or sell some valuable ones.

With their high dividends, REITs are great investments in terms of total return. In fact, some REITs have long-term returns that are higher than the market as a whole.

4. Liquidity

It might take a while to sell or buy a house. On the other hand, REITs are a tremendous liquid investment. With just one click of a button, investors can sell or buy a REIT whenever they want. If you need the cash from your investment, it’s easy to get it.

5. Commercial Real Estate Access

Another benefit of REITs is that they let you put your money to work in commercial real estate if you want to invest in it. Most of the time, many people can’t buy a Class A office building on their own. With REITs, individuals could own a part of thousands of data centers, apartment buildings, and even shopping malls.

CONs Of Investing In REITs

1. Interest Rates

Most investments are based on several things, but REITs can be very sensitive to changes in interest rates. If interest rates go up, the price of REITs could go down. The value of the trust is basically tied to the yield on the Treasury, so when the yield goes up, the value of the REIT is likely to go down.

2. Taxes On Dividends

Even though you don’t have to worry about paying a corporate tax with REITs, you should know that, unlike with some other investments, the dividends are often taxed at a higher rate.

Most of the time, dividends are taxed at the same rate as long-term capital growth, which is lower than the values at which regular income is taxed. But a REIT’s dividends don’t make the cut for the capital gains tax rate. Most of the time, they are taxed like regular income.

3. Trends

Compared to some other types of investments, a REIT may be more likely to fail because of the risks that come with the property itself. For example, if someone invests in REITs that have a portfolio of yogurt shops in strip malls, their investments could lose money if strip malls or yogurt, in general, go out of style.

Trends can affect investments, but REITs may be affected by trends that are specific to the type of property or location, which can be more challenging for investors to notice.

4. High Costs And Risks

Before investing in REITs, you should research and consider several real estate market factors, such as interest rates, changing tax laws, location, debt, and property values. This is because some REITs may charge high transaction and management fees, which would mean that shareholders would get less money back.

Most of the time, they put these fees in the small print. So, don’t be afraid to take more time to carefully read the fine print to find out more about things like acquisition fees and property management, among other things.

5. Returns Take Too Long

REITs are the best way to invest in real estate for the long term. Aside from changes in interest rates, there are many other things that can quickly change the price of REITs. If you need the money in the next few years, don’t put it in REITs because these investments work best with a longer time frame. If you want to invest for the short term, a REIT might not be for you.

Key Takeaway

The potential advantages of investing in REITs far outweigh the risks for many investors. While diversifying your portfolio can be a good idea, you should be well-informed before making any major investments. The preceding list of pros and cons for REIT investments should help you decide whether or not this type of investment is right for you.