If you own a home, you’re already invested in real estate. As the price of residential real estate in your area rises and falls, the value of your home increases and decreases. That’s far from the only way to be invested in real estate, though. There’s another, easier way called a real estate investment trust, or REIT.
Thinking of home ownership as an investment can be problematic, because it’s not a liquid investment. Even if prices doubled overnight, it’s unlikely you could sell your home quickly enough to get the full return on it. Even if you could, in order to take advantage of that “investment” paying off, you’d have to move to a different area with cheaper real estate prices. That means uprooting your family and possibly quitting your job. There are lots of reasons to own a home, but as a potential investment property your primary residence leaves a lot to be desired.
Even if you were willing to think of home ownership as investment in real estate, it’s not a very diversified one. In reality, your only exposure is to the residential real estate market in the area you live. It’s difficult to generate an income from residential real estate, and growth in this sector tends to be the slowest. Few people are taking a risk on home ownership while expecting significant returns down the line.
The best way to solve both of these problems is to own lots of pieces of different properties. This doesn’t mean buying your neighbor’s guest room and the front porch of the house across the street. Rather, it means pooling your money with a group of other investors to buy multiple properties, ideally in multiple markets and of multiple varieties. In a nutshell, that’s what an REIT does.
There’s one other tiny wrinkle that makes REITs different. They can also buy and sell mortgages. A mortgage is a type of ownership of property. If you have one, your financial institution “owns” part of your home, and they agree to let you live in it under the expectation that you’ll continue to make regular payments on that loan plus the interest they charge you. That mortgage, or part ownership of property, can be bought and sold just like the property itself. Some REITs only buy whole ownership of properties, some REITs just buy mortgages, and some do both.
Like real estate in general, REITs tend to be very safe investments. They’re backed by real property, and while the price of that property may fluctuate, it’s unlikely to lose all of its value. By the same token, it’s unlikely to experience rapid appreciation. Most investors view REITs as defensive investments to hedge against risk in other portions of their portfolios.
REITs have another function, too: income. Some REITs just buy rental property, and most of these tend to focus on commercial real estate. They charge rent to businesses that wish to set up shop. Most businesses work this way, even big chains like Wal-Mart and Target. They pay rent every month, and the REIT either uses that rent money to purchase more rental properties, or pays it out as a dividend to its shareholders. Dividend returns on REITs tend to be fairly stable, making them an excellent choice for those approaching retirement.
REITs are not without risk, though. Among the sectors that were hurt most by the 2008 recession, real estate tops the list. When things go wrong in the real estate sector, they tend to go very wrong. With that in mind, there’s not a lot of financial calamity that affects ONLY the real estate sector, meaning it’s hard to find unique risks that don’t apply to other classes of investments. REITs are safer than, say, technology securities, but riskier than bonds and CDs.
A diversified approach to investment means getting the most out of every market gain while losing the least in market dips. REITs can help investors achieve this goal by providing income and a reasonable return for a modest risk.