Investing in Real Estate Investment Trusts | Reasons not to Invest in REITS
The well-liked investment vehicles, real estate investment trusts (REITs) produce income for their investors. As a result, investors and customers usually use real estate investment trusts when making bets on the industry.
Because of this, REITs can provide investors with a consistent source of income, which is incredibly appealing in a low-interest-rate environment.
A way to add real estate to one’s financial portfolio is through REITs. Additionally, certain REITs could have higher dividend yields than some other investments.
However, there are REIT risks that people should be aware of before investing. Therefore, investors should closely review their REIT investments, just like they should with other financial instruments.
What are REITs?
People can engage in large-scale, income-producing real estate through REITs. A firm that owns and often manages real estate or similar purchases that generate income is called REIT. These include warehouses, self-storage facilities, office buildings, commercial centers, residences, hotels, resorts, and mortgages or loans.
A REIT does not build real estate properties to resell them like other real estate firms. On the other hand, a REIT buys and creates real estate mainly to operate it as part of its investment portfolio.
What types of REITs are there?
Many REITs are listed with the SEC and traded publicly on a stock exchange. The term “publicly traded REITs” refers to these. Others might be SEC-registered but not publicly traded. They are referred to as non-traded REITs (also known as non-exchange traded REITs).
One of the most significant differences between the different REIT types is this one. Knowing whether a REIT is publicly traded before investing in it is essential because it may have advantages and disadvantages.
Reasons not to invest in REITs
One way to add real estate in one’s financial portfolio is through REITs. Additionally, certain REITs could have higher dividend yields than some other investments. There are, however, inherent dangers, particularly with non-exchange traded REITs. Non-traded REITs have particular risks because they are not traded on a stock exchange, which is covered below.
REITs resemble mutual funds in every way. This implies that they also charge their clients a variety of costs. This is in addition to the commissions that REIT investors receive as a percentage of profits. The convoluted remuneration plans for managing several of these REIT trusts have drawn criticism from many investors. They increase the complexity of charging unknowing investors more money.
REITs need to see rapid value growth. This is because most of them are pass-through organizations. A dividend of about 90% of the rental income generated by these properties for the REITs is distributed to the investors. Only 10% is kept, and that’s only for administrative and emergency costs. Because of this, REITs typically are unable to expand the number of properties they manage. Any growth is merely the outcome of rising prices.
Share Value Transparency.
While the market price of a publicly traded REIT is readily available, estimating the value of a share of a non-traded REIT can take time and effort. Non-traded REITs typically reveal their estimated share value in 18 months following the closing of their offering. Years may pass after you make your investment before this happens. As a result, for a considerable amount of time, you might need help to determine the value and volatility of your non-traded REIT investment.
Lack of liquidity
Additionally, non-traded REITs are illiquid, which means that when an investor wishes to make a transaction, there might not be any buyers or sellers in the market. Non-traded REITs frequently have a minimum seven-year sales horizon. However, some charge a fee and permit investors to withdraw some of their money after a year.
Non-traded REITs must combine funds to acquire and manage properties, locking in investor funds. But this combined money may also have a sinister side. In contrast to the income that a property has produced, handing out dividends from the funds of other investors occasionally is the darker side. This procedure reduces the REIT’s cash flow and lowers the share value.
Interest rate risk
When interest rates increase and there is less demand for REITs, there is a greater danger. Investors often choose safer income options, like U.S. government bonds, in a rising-rate market. For example, treasuries. Government-backed Treasury securities typically have a set interest rate. Because of this, when rates increase, REITs decline, and the bond market soars as money pours into bonds.
It is possible to counter that rising interest rates are a sign of a strong economy, which would result in higher rents and occupancy rates. However, traditionally, REITs have struggled when interest rates increase.
Choosing the wrong REIT
Although it may sound overly simple, picking the wrong REIT poses another significant risk. For example, there has been a drop in suburban malls. Investors might want to avoid putting money into a REIT that has exposure to a suburban mall. Urban shopping complexes might be a better investment because Millennials favor urban living for its ease and ability to save money.
Research the holdings or properties within the REIT to ensure they are still relevant and can produce rental income because trends change.
Although not a danger in and of itself, the fact that REIT dividends are taxed as regular income may nonetheless be a big deal for some investors, in other words, the regular income tax rate is the same as the income tax rate paid by investors, which is probably higher than the rates on dividends or stock capital gains taxes.
What are fraudulent REITs?
Corrupt individuals trying to sell “REIT” investments that become scams may deceive some investors. To avoid this, invest exclusively in registered REITs, which can be found using the EDGAR tool provided by the SEC.
Do all REITs pay dividends?
The IRS and SEC will classify a company as a REIT if at least 90% of its taxable profits are distributed as dividends. Due to this clause, REIT businesses are excluded from most corporate income tax. However, regardless of the holding term, REIT dividends are taxed as ordinary income to shareholders.