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Advantages and Disadvantages of Investing in REITs - Mechanics Thunder Bay

Advantages and Disadvantages of Investing in REITs

disadvantages of reits

This can put a damper on broadly diversified REIT investment returns. Imagine that you buy a Vanguard REIT fund like VNQ for $76.00 per share and a 3.0% yield. You’ll still receive your dividend payment, but the total value of your investment will decline. Although you typically earn a juicy dividend on your real estate assets, you’ll have to pay taxes on those dividends, typically at a higher rate than the 15% levied on most dividends.

disadvantages of reits

Investors might also want to lessen their exposure in high-property-tax states. Hence, REITs that invest heavily in states such as Illinois, New Jersey and Texas would likely feel the most effect. However, with a real estate investment trust, managing these issues becomes the responsibility of the REIT itself. The responsibility of the unitholder consists of monitoring the equity and its distributions.

Investing in REITs vs Private Equity Real Estate

The above advantages and disadvantages will help you make a well-informed decision on whether or not to invest in REITs. One of the best things about investing in REITs is that you may enjoy a good return potential. This is especially true if the value of their underlying assets increases. Real estate values tend to increase in the long run, and REITs may use some strategies to create additional value. They could develop properties from scratch or sell some valuable properties to make the most of their capital. Investing in a REIT or a private equity syndication can yield a profitable outcome, so real estate investors must determine which is the better fit for their unique circumstances.

disadvantages of reits

The benefits of a REIT investment include liquidity, diversification, and passive income in the form of high dividends. The potential downsides of a REIT investment include taxes, fees, and market volatility due to interest rate movements or trends in the real estate market. Real estate investment trusts are historically one of the best-performing asset classes. The FTSE NAREIT Equity REIT Index is what most investors use to gauge the performance of the U.S. real estate market.

Pros of REIT Investing

For instance, the best apartment markets tend to be where home affordability is low relative to the rest of the country. In places like New York and Los Angeles, the high cost of single homes forces more people to rent, which drives up the price landlords can charge each month. As a result, the biggest residential REITs tend to focus on large urban centers. That said, there are longer-term concerns for the retail REIT space in that shopping is increasingly shifting away from the mall model to online. Owners of space have continued to innovate to fill their space with offices and other non-retail oriented tenants, but the subsector is under pressure. Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics.

The nature of REITs gives them several benefits that mutual funds do not. Another perks of direct real estate is that you have more control over decision making than you would with REITs. For example, you can select only properties that match your preferences for location, property type, and financing structure. You can set rental prices, choose tenants, and decide how many properties to buy.

Pros and Cons of Investing in REITs

REITs provide an income stream as they are required by law to pay out at least 90% of their income in dividends. The properties owned by REIT companies can appreciate in value over time, thus growing your initial investment. REITs are professionally managed, to get the greatest returns on the individual properties. REITs provide diversification to a stock and bond portfolio and can curb portfolio losses should stock prices fall.

  • They earn money on the difference between short-term interest rates and the rates charged through their loans.
  • When a REIT sells a property to get a long-term capital gain, though, shareholders get favorable treatment on the corresponding portion of their income allocable to the gain.
  • REITs must pay a dividend, making them a great way to earn passive income.
  • With Millennials preferring urban living for convenience and cost-saving purposes, urban shopping centers could be a better play.

You may already own some REITs and not even know it, especially if you own an index fund based on the Standard & Poor’s 500 stock index. Below are five different ways that you can get into the REIT game, although for three of them you’re going to need a brokerage account first. The first and only national digital and print magazine that connects individuals, families, and businesses to FEE-ONLY financial advisers, CPAs and attorneys. DollarBreak is reader-supported, when you sign up through links on this post, we may receive compensation. You’ve probably used Cash App to send money to friends or make contactless payments.

Should You Consider Investing In REITs? 10 Pros And Cons

Many investors find they are able to withstand short-term market fluctuations better knowing they own tangible investments. Although not a risk per se, it can be a significant factor for some investors that REIT dividends are taxed as ordinary income. In other words, the ordinary income tax rate is the same as an investor’s income tax rate, which is likely higher than dividend tax rates or capital gains taxes for stocks. Another benefit is that REITs offer enticing total return potential. By law, REITs have to pay at least 90% of taxable income to shareholders, and it’s not uncommon to have a 5% dividend yield—or more. REITs also have the potential for capital appreciation as the value of the underlying assets increases.

As a result, investors may experience volatility in a publicly traded REIT portfolio, and a higher correlation to stock price swings. That means real estate diversification through public REITs provides less protection than directly owning properties. For example, invest only in one stock market mutual fund and when the stock market falls 20% in a bad year, so do your investment returns. Add a bond mutual fund to the stock fund and even if the returns on the stock fund fall, the bond fund’s returns might go up 15% and make your total portfolio value more stable.

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