Investing in commercial real estate offers multiple avenues, and each investor must find the approach that suits them best. While purchasing a property directly is often considered the most straightforward method, it requires significant time, expertise, and resources. However, not all real estate investors possess these prerequisites for property ownership and management. In such cases, fractional ownership of a commercial property through purchasing shares in a Real Estate Investment Trust – REIT for short – can be an appealing alternative.

This article serves as a guide to investing in REITs. We will provide a clear understanding of what REITs are, outline the advantages they offer, and shed light on the potential risks associated with such investments. By the end, readers will be equipped with valuable insights to make informed decisions regarding REIT investments.

What Is a REIT?

REITs are companies that own, operate or finance income-generating real estate properties. Like mutual funds, REITs pool the capital of multiple investors, allowing individuals to earn dividends from real estate investments without the need to personally purchase, manage, or finance properties.

In 1960, Congress established REITs through an amendment to the Cigar Excise Tax Extension. This provision opened up opportunities for investors to acquire shares in commercial real estate portfolios, which were previously accessible only to wealthy individuals or large financial intermediaries.

REIT portfolios comprise various types of properties, including apartment complexes, data centers, healthcare facilities, hotels, infrastructure such as fiber cables, cell towers, energy pipelines, office buildings, retail centers, self-storage facilities, timberland, and warehouses. While some REITs specialize in specific sectors, others maintain diversified or specialty portfolios encompassing different property types. For example, some REITs include both office and retail properties within their portfolios.

Many REITs are publicly traded on major securities exchanges, enabling investors to buy and sell shares like stocks during regular trading sessions. These publicly traded REITs often exhibit high trading volume, offering liquidity to investors seeking to enter or exit their positions.

In general, there are four main types of REITs:

  1. Equity REITs: The majority of REITs fall into this category. Equity REITs provide investors with an equity ownership stake in a diversified portfolio of commercial real estate properties. Investors receive a proportional share of the cash flow and profits generated by these properties. Most equity REITs specialize in specific asset classes such as shopping centers, data centers, self-storage facilities, or healthcare facilities.
  2. Mortgage REITs (mREITs): Mortgage REITs focus on providing financing for purchasing real estate assets. While they may invest in both residential and commercial mortgages, residential mortgages are more commonly targeted. Mortgage REITs generate income through interest payments on the mortgages they hold, and they may also invest in mortgage-backed securities or other debt instruments.
  3.  Public Non-Listed REITs: Public non-listed REITs are registered with the Securities and Exchange Commission (SEC) but are not traded on public exchanges. These REITs may specialize in specific asset classes but lack the high degree of liquidity associated with publicly traded REITs since their shares cannot be bought and sold on public exchanges. Investors in public non-listed REITs typically face restrictions on redeeming their shares.
  4. Private REITs (Non-Traded REITs): Private REITs, also known as non-traded REITs, are exempt from SEC registration requirements as long as they adhere to specific rules. Private REITs often restrict share sales to accredited investors. Unlike publicly traded REITs, private REITs do not trade on public exchanges, resulting in significantly lower liquidity. Investors may face challenges when trying to sell their shares, and redemption programs, if available, may have limitations.

It is important for investors to carefully consider the characteristics and features of each REIT type, considering factors such as risk tolerance, liquidity needs, and investment objectives before making investment decisions.

Benefits of Investing in Commercial Real Estate through REITs

Enhanced Diversification

Investing in REITs allows for diversification across various commercial property types, such as office buildings, retail spaces, hotels, and warehouses. This diversification reduces risk by spreading investments across multiple properties instead of relying on a single property’s performance.

Increased Accessibility

Unlike direct real estate investments that typically require significant capital, investing in REITs offers a more accessible entry point into the commercial real estate market. Investors can participate and potentially benefit from the returns of commercial real estate with lower investment amounts.

Improved Liquidity

REITs provide a higher level of liquidity compared to direct real estate investments. Being publicly traded on stock exchanges, investors can easily buy or sell REIT shares at market prices. This liquidity offers flexibility and the ability to quickly adjust investment positions when needed.

Professional Management Expertise

Experienced real estate professionals with specialized knowledge of the industry manage REITs. These professionals handle property acquisitions, leasing, maintenance, and other operational aspects. By investing in a REIT, individual investors can gain exposure to the commercial real estate market while benefiting from professional management without the need for direct property oversight.

Reliable Dividend Income

REITs are legally obligated to distribute a significant portion of their taxable income to shareholders through dividends. This regular income stream can be particularly appealing for investors seeking consistent cash flow, especially in a low-interest-rate environment. Additionally, the dividends received from REITs often have favorable tax treatment, making them potentially more advantageous than other forms of investment income.

By considering these advantages, potential investors can assess whether investing in commercial real estate through REITs aligns with their investment goals and risk tolerance. It is important to conduct thorough research, evaluate specific REITs, and consult with financial professionals before making any investment decisions.

Potential Risks of Investing in Commercial Real Estate through REITs

Market Volatility

Commercial real estate and REIT investments are susceptible to market fluctuations and economic cycles. Changes in market conditions, investor sentiment, or broader economic factors can impact the performance and value of commercial real estate properties held by REITs. Investors should be prepared for potential volatility in the value of their investments.

Interest Rate Sensitivity

REITs can be influenced by changes in interest rates. When interest rates rise, the cost of borrowing for real estate acquisitions may increase, potentially affecting the profitability of the properties owned by the REIT. Investors should consider the potential impact of interest rate movements on the performance of their REIT investments.

Property-Specific Risks

While REITs offer diversification, each property within the portfolio carries its own risks. Factors such as location, tenant quality, lease terms, property management, and market conditions can significantly impact the financial performance of individual properties and, consequently, the overall returns of the REIT. Investors should carefully assess the quality and characteristics of the properties held by the REIT.

Regulatory Risks

REITs are subject to specific regulations and tax requirements. Changes in these regulations, such as alterations to tax laws or real estate regulations, can affect REITs’ profitability and operational structure. Investors should stay informed about regulatory developments that could impact their REIT investments and be prepared to adapt to potential changes.

By understanding and considering these risks, potential investors can make informed decisions and ensure that investing in commercial real estate through REITs aligns with their risk tolerance and investment objectives. Conducting thorough due diligence, diversifying investments, and seeking professional advice can help mitigate these risks.

Final thoughts

By understanding the advantages and risks of investing in commercial real estate through REITs, potential investors can make informed decisions that align with their investment goals. It is advisable to consult with financial professionals who can provide guidance tailored to individual circumstances. With careful consideration and due diligence, investing in commercial real estate through REITs can be a valuable addition to an investment portfolio.