What is a REIT and how does it work?

What is a REIT?

A real estate investment trust (REIT) is a company that invests in and finances property.¹ Like a managed investment fund, it gives traders and investors access to a basket of real estate investments, When you invest in REITs, you could generate dividend income from them without them having to own the property outright.

REITs do sometimes offer tax breaks, making them popular among some investors. You should always consult with a tax practitioner on this matter.

A real estate investment trust's portfolio can be made up of lots of different types of property assets. Examples of such assets include commercial property – like warehouse, offices, shopping centres and hotels – and residential property, such as apartment blocks and aged care villages.

How does a REIT work?

Like other listed companies, REITs are publicly traded on most major stock exchanges around the world, such as the Australian Stock Exchange, the London Stock Exchange and the New York Stock Exchange. You can buy and sell shares in them during global stock market trading hours and Australia's trading hours. There are also specific REIT exchange-traded funds (ETFs) that invest in a number of different real estate investment trusts.

For a company to be able to register as a REIT in Australia, it must follow certain strict rules that apply to managed investment schemes. This includes the requirement to invest at least 80% of the trust's assets in real property or entities that hold real property. Trusts must also distribute at least 90% of their net income to investors annually.

REITs can invest in a variety of property assets. For example, Scentre Group invests in Westfield shopping centres, while Dexus Industria REIT invests in offices and industrial properties businesses use as workplaces. National Storage REIT, on the other hand, invests in self-storage facilities.

Different types of REITs

As well as REITs that target different property sectors, there are different types of REITs available to traders and investors.

Publicly traded REITs

There are publicly traded REITs, like Goodman Group and Charter Hall Long WALE REIT, where investors can purchase and sell their shares on major stock exchanges around the world. These REITs are easily accessible to retail investors but, because they are publicly traded, share price performance can vary.²

Public non-traded REITs

Public non-traded REITs cannot be traded on major stock exchanges. These can provide you with an entry into difficult-to-access real estate investments with smaller capital requirements. However, they’re high-risk investments compared to publicly traded REITs.

These entities are designed to reduce tax paid on investments, but because they’re not regularly traded they can be relatively illiquid and their fees tend to be higher. However, they must still be registered with the relevant regulator in their country of origin.

Public non-traded REITs typically have a finite maturity date and will end in the trust being dissolved or listed on a stock exchange.

Private non-traded REITs

There are also privately held non-traded REITs, which private investors generally don’t have access to. These are typically held by high net-worth individuals.

REITs categorised by asset type

Equity REITs

Equity REITs invest directly in property and are traded on the stock exchange. They own and manage portfolios that can include commercial property, like warehouses, hotels, office buildings or other real estate assets.

Mortgage REITs

These REITs invest in mortgages and mortgage securities, providing financing for other property companies or purchasing that financing and earning income from the interest charged on the loans.³

Hybrid REITs

Hybrid REITs combine the characteristics of both equity and mortgage REITs. They own and manage property portfolios but also make income from mortgages.

How to trade or invest in REITs

So, how do you go about trading in REITs?

1. Learn more about REITs

Do your own research to find out more about REITs and whether they’re the kind of financial asset you’d want exposure to. Decide which types of real estate investment trusts and which specific REITs you would like to trade or invest in.

2. Open a share trading account

Open an account to start buying and selling shares and ETFs

3. Select your opportunity

When you're ready, decide which type of REIT you wish to trade or invest in – find it using our search bar or looking under 'shares'.

4. Choose your position size and manage your risk

Decide how much money you want to use to trade or invest, and for how long you want to hold a position. Think about your risk profile, introduce stop-losses and always consider how much you can afford to lose.

5. Place your deal and monitor your trade

You can invest in REITs directly, or in REIT ETFs, through our share trading account. Alternatively you can trade REITs through our CFD trading account. It is important to be aware that CFDs are complex products that may magnify any potential profits and losses, making them a high-risk trading strategy that could potentially result in the loss of more than your initial deposit.

Pros and cons of REITs

Pros:

Real estate investment trusts are generally exempt from taxation at the trust level, provided they distribute at least 90% of their income to their shareholders.⁴ Rental income is seen as business income, meaning a REIT can deduct all expenses related to rental activities, just as a corporation can write off business expenses.

In addition, current income distributed to shareholders isn’t taxed to the REIT. This means that, unlike a company, any profits won’t be subject to company tax.

Property rental income tends to be relatively stable, as most commercial tenants sign up for leases lasting between three and ten years. This often makes for a relatively stable source of income for both the REIT and its investors. Dividend yields on REITs do vary, however, depending on the sector and performance. That's why you need to do your own research and select investments that are right for you.

REITs can offer a good way for retail traders and investors to diversify their portfolios and access real estate markets without costly financial outlays or taking on the risk of owning property themselves.

Cons:

No trade or investment is without risk, and REITs can and do go bankrupt – so it's important to do your own research. One downside of these investment trusts is that, due to the rigid structure of the dividend pay-outs, it can be difficult for the companies to reinvest capital back into the business for future growth.

The share prices of publicly traded REITs are subject to market volatility and outside factors, such as the economy and interest rate decisions, but information about them is at least publicly available through the company's annual results and income statements.

Non-traded REITs, on the other hand, tend to be illiquid and there’s little publicly available information about them. Investors' money may be tied up in them for years. Entry costs to access these trusts can also be expensive.

There are other forms of risk too, such as leverage risk. This is where REITs may borrow money to purchase investments – in turn, these might increase the fund's losses because of fees or other reasons. It is worth checking how heavily geared a REIT is before investing in it.

Although listed REITs may be more liquid than non-traded REITs, they still tend to be less liquid than other types of securities.

REITS summed up

• Real estate investment trusts have a place in a diversified and balanced portfolio
• They are a popular way for traders and investors to access property markets without having to invest directly in real estate themselves
• Real estate investment trusts are generally exempt from taxation at the trust level, provided they distribute at least 90% of their income to their shareholders
• Property rental income tends to be relatively reliable
• Non-traded REITs tend to be illiquid and there’s little publicly available information about them. Entry costs to access these trusts can also be expensive
• REITs can be subject to market volatility. Always do your own research before trading or investing

Find out more about how to invest in REITs with us.

¹ Investing in A-REITs – ASX
² REIT in Australia – Canstar
³ REIT definition – Fool.com