Real Estate Investing, Simplified.

Main points

  • A real estate investment trust (REIT) is a company that owns income-producing real estate.
  • You can buy and sell shares of REITs through a brokerage account, just like investing in stocks.
  • REITs pay high dividends, but these are non-qualified dividends that are taxed as ordinary income.

Real estate is a popular investment. The traditional way to do this is to buy a property that you can use for rental income or sell for a profit, but this is not an option for everyone. It’s time-consuming, it’s expensive, and it’s risky, because you’ll be tying up a lot of your money in the property you buy.

The good news is that there is a very accessible option. These are called real estate investment trusts (REITs), and if you like to invest in real estate, one of these could be a great addition to your portfolio.

What is a REIT?

A REIT is a company that owns, and in many cases operates and finances, income-producing real estate. REITs have been around since the 1960s, when Congress established them so that any investor would have the opportunity to invest in commercial real estate.

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Investing in REITs is similar to investing in stocks. They are bought and sold in shares, and most REITs are publicly traded, meaning you can invest in them through a brokerage account.

There are many types of REITs available, including residential REITs, office REITs, retail REITs, and healthcare REITs. If you have a specific type of property or market sector in which you want to invest, you can focus on that type of REIT.

Pros and cons of investing in REITs

Investing in REITs has many advantages:

  • They pay high dividends, making them great for earning passive income. REITs are required by law to pay out at least 90% of taxable income as dividends.
  • They make it easy to invest in real estate. You don’t have to worry about coming up with a big down payment to buy a property. Because REITs are bought and sold like stocks, it’s also much easier and faster to sell them.
  • They diversify your portfolio. Real estate also tends to be less volatile than the stock market.

Like any investment, REITs have their drawbacks. They often decrease in value when interest rates rise. Performance will also depend on the REITs you invest in.

One of the biggest pitfalls to be aware of with REITs is how they increase your tax liability. They pay non-qualified dividends, which are dividends that are taxed as ordinary income. So, while you may earn more passive income from REITs, you’ll also pay more in taxes.

Fortunately, there is a way around it. If you invest in REITs through an Individual Retirement Account (IRA), you don’t pay dividend taxes each year. Here’s how the REIT tax works with each type of IRA:

  • With traditional IRAs, you don’t pay taxes until you withdraw the funds, and contributions are tax deductible.
  • With Roth IRAs, withdrawals are tax-free, but you contribute to after-tax earnings.

Should you invest in REITs?

REITs are a good investment that has performed well over the years. Over the last 45 years, they have had an average compound annual return of 11.4%. This is roughly in line with the S&P 500, an index tracking the 500 largest publicly traded companies on US stock exchanges, which had a return of 11.5%.

It may not be an absolute must-have, but a REIT is worth considering to diversify your portfolio. REITs are a good fit, especially, if any of the following are true:

  • You want to invest in real estate.
  • You want to earn more passive income from your investments.
  • You have a stock-heavy portfolio and want to reduce volatility.

If you decide to invest, you can choose individual REITs. Or, you can look into REIT ETFs. It invests your money in multiple REITs and real estate stocks, which comes with less risk than investing in a single REIT.

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