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 standard actively managed investment fund, it enables investors to buy into a basket of real estate investments and generate dividend income from them without them having to own the property outright.

REITs also benefit from tax breaks, making them attractive to certain investors.

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 warehouses and office blocks – and residential property, such as apartment blocks.

How does a REIT work?

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

For a company to be able to register as a REIT, it must follow certain strict rules. For example, 75% of the REIT's profits must be generated from renting out its property portfolio, and 75% of its assets must also be available for rental purposes. The remaining 25% of profits can be generated from other means – and REITS often diversify into the allied area of property development.

What's more, to qualify as a REIT in the UK and US, 90% of the REIT's profits from renting out properties must be distributed to investors in the form of dividends. However, the REIT does not have to pay out its profits from the 25% of its other activities – such as property development – to shareholders in the same manner.

In the US, the REIT's parent company must also be registered in US. In the UK, the REIT's parent company must be registered in Britain. Moreover, the company must own at least three properties to qualify as a real estate investment trust.

REITs can invest in a variety of types of property assets. For example, Primary Health Properties invests in doctors' surgeries, while Big Yellow owns storage units and warehouses. The NewRiver REIT, meanwhile, invests in UK-based commercial properties.

Learn about some of the best REITs in the UK.

Different types of REITs

As well as REITs that invest in different property sectors, there are also several types of real estate investment trusts.

Publicly traded REITs

There are publicly traded REITs, like British Land and Tritax Big Box REIT, from which shares can be bought and sold on major stock exchanges around the world. They are easily accessible to retail investors but, because they are publicly traded, the share price performance can vary.²

Public non-traded REITs

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

These entities are designed to reduce tax paid on investments and, because they are not regularly traded, can be relatively illiquid investments. However, they must still be registered with the relevant regulator in their country of origin. The fees for these types of investments tend to be higher, and it can be more difficult to exit the investment.

Public non-traded REITs typically have a finite maturity date, and they will either 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 do not have access to. These are typically held by high net-worth individuals.

REITs categorised by asset type

Equity REITs

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

Mortgage REITs

Mortgage 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 are the right kind of investment for you. Decide which types of real estate investment trusts, and then which specific REITs you would like to trade in

2. Open an account or practise on a demo

Open an account to start trading, or practise with a demo account

3. Select your opportunity

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

4. Choose your position size and manage your risk

Decide how much you wish to invest and for how long. Think about your risk profile and whether the investment is right for you. Introduce stop-losses if necessary. Consider how much you can afford to lose

5. Place your deal and monitor your trade

You can invest in REITs directly through our share dealing account. Alternatively, you can also trade REIT stocks through CFDs and spread betting, or invest in REIT exchange-traded funds (ETFs)

Pros and cons of REITs

Pros:

Real estate investment trusts enjoy certain tax benefits.⁴ They do not pay corporation tax on rental income or gains on the sale of investment properties that have previously been rented out.

Property rental income tends to be relatively stable, as most tenants sign up for leases lasting between five and 25 years. This makes for solid, reliable income for both the REIT and its investors. Dividend yields on REITs do vary, however, depending on the sector and performance. As such, investors need to do their own research and select the right investments for them.

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

Cons:

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

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.

However, non-traded REITs tend to be illiquid, and there is little publicly available information about them. Further, investors' money may be tied up in them for years. Upfront 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 issues.

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

REITS summed up

• Real estate investment trusts have a place in a diversified and balanced investment portfolio
• They can be a good way for investors to access property markets without having to invest directly in real estate themselves
• REITS enjoy certain tax benefits, such as exemption from corporation tax
• Property rental income tends to be relatively reliable
• REITS can be subject to market volatility. Always do your own research before investing

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

_{1 Everything you need to know about UK REITs (reitcomparison.co.uk)
2 Real Estate Investment Trust (REIT): How They Work and How to Invest (investopedia.com)
3 UK REITs - An attractive vehicle for UK property investment - PwC UK
4 What is a REIT (Real Estate Investment Trust)? | REIT.com}