When it comes to high passive income potential, few investments rival real estate investment trusts (REITs). They also make fine additions to fixed-income or equity portfolios because they serve as a counterbalance to stocks, bonds, and cash equivalents. In this article, we will introduce you to REITs, point out their advantages as a passive income investment, reveal how to invest in REITs, and suggest five available REIT types.
What Are REITs?
In 1960, the U.S. Congress created real estate investment trusts (REITs) with the Cigar Excise Tax Extension. The federal government’s intention was to provide all investors with the opportunity to invest in large-scale portfolios of real estate assets. As a result, this legislation effectively penetrated the monopoly on the real estate industry by the mega-wealthy and financial institutions.
Basically, REITs are companies that invest in income-producing real estate with the obligation of passing a bulk of the revenue on to their shareholders. By law, REITs must earn at least 75% of their gross income from real estate-related interests, and at least 75% of their total assets must go toward investing in real estate. Also, the law requires REITs to disperse at least 90% of their taxable earnings to shareholders in the form of dividends derived from rent and fees.
How to Invest in REITs for Passive Income
REITs operate under two main categories: public and private. Most investors deal with publicly traded REITs because they are SEC-registered and offer their shares on the public stock exchanges. You can trade shares in a particular company, exchange-traded fund (ETF), or a mutual fund. For your protection, publicly traded REITs provide you with the security of SEC regulation, public reporting, and transparent trading.
Benefits of Investing in REITs for Passive Income
From a historical standpoint, real estate investment trusts are among the highest-performing asset classes on the market. For example, according to the Financial Times Stock Exchange group, the NAREIT Equity REIT Index’s average annual return was 9.5% between 2010 and 2020 and 11.25% from 2017 through 2020. In addition, some other benefits include the following:
Total return investment and tax breaks: REIT provides possibly higher-than-average dividends income and moderate long-term capital appreciation. To top it off, the Tax Cut and Jobs Act of 2017 gives you a substantial deduction on your dividend income.
Inflation hedge: REITs differ from other businesses because they benefit from inflation. The guidelines for REIT leases allow for frequent rent increases and rent hikes related to the consumer price index (CPI). Also, inflation raises the value of the REIT assets, which increases the worth of the companies’ portfolios.
Liquidity: Unlike other real estate investments, many REITs don’t bind your money in a long-term contract because you can trade them on the stock market. This advantage gives you the liquidity to pull out any time. However, some REITs are not as liquid.
How Do You Find The Right Type of REIT For Your Investment Needs?
When you begin your search for suitable REITs, you will notice that they appear in sector-focused categories based on the type of properties in their portfolios. However, the types of REITs vary along with a wide range of sectors. These five REITs on our list represent that diversity.
1. Office REITs
Office REITs specialize in investing in office buildings and benefit from the rent revenue from commercial tenants who typically have long-term leases. As a result, these REITs rely heavily on the state of the economy and business trends. Therefore, when considering an office REIT, you should know the vacancy rate of its properties and the economic conditions of the areas where its tenants do business. Also, you should consider specific macroeconomic indicators like the unemployment rate and interest rates.
2. Mobile Tower REITs
Most people don’t realize that mobile communication companies like Crown Castle International, American Towers, and SBA Communications are in the real estate business. But they are, and their renters include all of the major cellular carriers and beyond, providing a substantial, consistent rent flow, long leases, and high payouts.
With the expansion of 5G and broadband, the future appears very bright for these mobile tower REITs. For example, the market for 5G was $41.48 billion in 2020, and it has a projected compound annual growth rate (CAGR) of 46.2% through 2028. According to WirelessEstimator.com, slightly over 100 companies own 130,597 towers and over 4,000 mobile wireless cell sites in the U.S.
The big three that we mentioned own more than 75% of the critical domestic infrastructure and most of the world’s telecommunications infrastructure supply chain. However, these companies’ incredibly high stock prices can suppress their dividend yield, but the safety of the passive income investment would be hard to beat.
3. Retail REITs
REIT-owned shopping malls and retail structures represent the US’s most significant type of investment. Practically every shopping center you’ve ever walked into was REIT-owned. With the retail industry looking very healthy at this point, retail REITs deserve serious consideration from most investors.
However, retail REITs survive from the rent they collect from tenants. Due to slow sales, retailers facing challenging times could postpone or default on their monthly rent, leading to possible eviction and an expensive search for a new tenant. For this reason, you should shop for REITs with solid anchor tenants like big-box retailers, supermarkets, and hardware stores.
4. Healthcare REITs
Since healthcare REITs invest in the real estate occupied by hospitals and other healthcare facilities, their livelihood depends on the prosperity of the healthcare system. In addition, the tenants on these properties rely on Medicare and Medicaid reimbursements along with occupancy fees and private pay. So, any healthcare funding issues directly affect healthcare REITs.
5. Mortgage REITs
A majority of REITs invest in real estate. However, about one-tenth of them invest in mortgages acquired in the secondary market by institutions like Fannie Mae, Freddie Mac, and government-sponsored enterprises.
Although investing in mortgages is a relatively safe practice, this industry faces risks because rising interest rates lower mortgage REITs’ book value and stock prices. However, high-interest periods provide an excellent opportunity for you to buy mortgage REITs at a discount.
REITs as Your Source of Passive Income
Many years ago, the ability to tap into passive income from sizable real estate holdings was only available to wealthy investors. Now, thanks to the federal government, REITs provide a reasonably safe, liquid, and convenient way to collect passive income from real estate-related investments without committing large amounts of money. At the same time, all REITs are not the same. You must do your due diligence to find the REITs that fit your investment criteria.