Can you lose money in a REIT?
To make as much money as possible, mortgage REITs tend to use a lot of debt—like $5 of debt for every $1 in cash, and sometimes even more. Plus, the interest rate on those short-term loans could increase, leading to smaller profits than expected—or even a loss.
Both bonds and REITs generate a consistent income stream, albeit in different ways. Bonds provide fixed-interest payments, while REITs distribute regular dividend payouts. Generally, both investment types are seen as lower-risk options compared to stocks.
Steady dividends: Because REITs are required to pay at least 90% of their annual income as shareholder dividends, they consistently offer some of the highest dividend yields in the stock market. That makes them a favorite among investors looking for a steady stream of income.
The potential downsides, or CONS, of a REIT investment include the fact that they are taxed as income, the variation in the fee structures of different managers, and market volatility due to interest rate movements or trends in the real estate market.
Finally, a REIT is not a pass-through entity. This means that, unlike a partnership, a REIT cannot pass any tax losses through to its investors. Consider consulting your tax adviser before investing in REITs. The Office of Investor Education and Advocacy has provided this information as a service to investors.
REIT bankruptcies have indeed been a rarity since the REIT debacle of the mid-1970s, when high leverage and highly speculative real estate investments resulted in numerous REIT failures.
Investing in certain types of REITs, such as those that invest in hotel properties, is not a great choice during an economic downturn. Investing in other types of real estate such as healthcare facilities or retail is a great way to hedge against a recession.
Their dividend rate is higher than most equities or other fixed-income investments. REITs have a low correlation with other assets, which makes them an excellent choice for portfolio diversification. REITs are highly liquid; if you need to pull your money out, you simply sell your shares on a stock exchange.
It should come as no surprise that one place billionaires keep their money is in real estate. One of the most common ways to invest in real estate without worrying about constant maintenance is to put your money into real estate investment trusts (REITs).
- Poor / over-leveraged balance sheet. For e.g. interest from their debt is higher than their rental revenue.
- Lack of tenant diversification. The REIT is solely dependant on a single or handful of clients.
- Short leases.
- Realizing a capital loss. This is the most common way investors lose money in REITs.
Should I avoid REITs?
However, REITs are not risk-free: they may have highly inconsistent, variable returns, are sensitive to interest rate changes are liable to income taxes may not be liquid, and can be dramatically affected by fees.
Higher interest rates can also make REITs less attractive compared to other income-generating investments, such as bonds. Taxed as ordinary income: Dividends from REITs are typically taxed as ordinary income, which can result in a higher tax burden for investors, especially those in higher tax brackets.
If the REIT fails this ownership test for more than 30 days (31 days if the year has 366 days) in a taxable year of 12 months, it can lose REIT status and cannot elect to be treated as a REIT for five years (IRCазза856(a)-(b)). The test is pro-rated for taxable years shorter than 12 months.
By law, REITs must distribute at least 90% of their taxable income to shareholders. This means most dividends investors receive are taxed as ordinary income at their marginal tax rates rather than lower qualified dividend rates. Any profit is subject to capital gains tax when investors sell REIT shares.
While they provide a compelling set of benefits, it should be noted that, like any investment, non-traded REITs come with risks, including illiquidity, loss of principal, real estate risks, and more.
REIT share prices, like the broader stock market, often react to changes in the outlook for interest rates, including both the short-term rates set by the Federal Reserve and the long-term rates that are governed more by market forces.
Interest Rates. During periods of economic growth, REIT prices tend to rise along with interest rates. The reason is that a growing economy increases the value of REITs because the value of their underlying real estate assets increases.
- A REIT can be more expensive
- Limit to type of assets and fees
- Losses do not pass to investors
- Ordinary dividends taxed as ordinary rates
- Dividends subject to net investment income tax
- Cannot make inside basis adjustments when stock is purchased
- Stock for services is taxable
When investing in a REIT, the maximum loss is the total invested amount. The two ways an investor can benefit from an investment in a REIT are the regular income distributions and a potential price increase. Generally speaking, returns on REITs are from dividends rather than price appreciation.
Due in part to their attractive current yields, REITs have tended to deliver annualized total returns to investors of 10 to 12 percent over time.
Are REITs high risk?
Compared to other investments such as stocks and bonds, REITs are subject to various risk factors that affect the investor's returns. Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.
FALLING REAL YIELDS MAY SPARK REIT RALLY
With real yields appearing to have peaked in late 2023, prospects of falling interest costs and lower discount rates may provide meaningful tailwinds for the capital intensive, long-duration REIT market.
In many cases, this can take around 10 years to occur. And with publicly traded REITs that fluctuate with the stock market, Jhangiani recommends holding onto them for at least three years.
Publicly-traded REITs offer the advantage of liquidity, since individual investors can sell their shares at any time. Privately-traded REITs don't offer this liquidity, but may offer higher dividends. REIT shares are eligible for a step-up in basis upon death, just like real property investments.
While real estate has never been a big part of Buffett's investing strategy, Berkshire Hathaway has owned shares of STORE Capital, a REIT focused on single-tenant operational real estate.
