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What Is A REIT?
When it comes to how they operate, there are largely two kinds of REITs available, namely mortgage REITs, and equity REITs, with the latter being the most common. And when looking at accessibility, you may have a publicly traded REIT or a private REIT.
Some REITs may even distinguish themselves from others by offering investors common stock and preferred stock options.
REITs also have to meet particular criteria before they can be considered a REIT. Industry group NAREIT states that the company must distribute 90% of its taxable income to shareholders as dividends and have at least 75% of its assets in real estate.
What is a residential REIT?
A residential REIT focuses solely on residential real estate. Some target assets like apartment buildings, whereas others will specialize in a type of residential property like senior housing. Others will target a specific type of investor, such as individuals with a high net income.
Some residential REITs focus on developing new properties, where others will primarily focus on acquiring existing properties. Residential REITs that focus on acquisition will often add value to the property through renovations.
Avalonbay Communities is an example of a large, publicly-traded REIT that develops and redevelops multifamily properties. As of Jan 2021, they owned over 79000 apartment units.
How Have REITs Performed Historically?
Historically, real estate investments are one of the best-performing asset classes available. Most REIT investors use the FTSE NAREIT Equity Index to judge the performance of the US housing market.
The three-year average return for REITs between November 2017 and November 2020 was 11.25%. By way of comparison, the average return over the same period for The S&P 500 was 9.07%.
3 Benefits Of Investing In Residential REITs
Residential REITs come with lots of benefits, but a few noteworthy ones include:
1. Long-term returns
REITs, in general, also offer the potential for fantastic long-term performance with a high dividend yield.
While your income may fluctuate year on year, your returns are likely to outperform many other investments over the long term.
This is in part because of dividend growth and rent growth from rising rental rates. Therefore, the longer you hold your investment, the greater your expected returns are likely to be.
Many residential REITs (especially rental ones) also distribute a monthly dividend to investors generating passive income.
REITs tend to offer excellent transparency. Real estate trusts usually employ independent analysts and auditors to perform various inspections on the properties.
REITs will often provide these reports to investors, containing valuable information, such as what repairs the property may need, the property’s value, and more. This information can help investors make an informed investment decision.
3. Portfolio diversification
Residential REITs can also be very effective in creating a more diversified portfolio. Real estate, in general, shares a low correlation with traditional asset classes like stocks and bonds, and REITs are a fantastic way of taking advantage of this low correlation.
This helps shield your portfolio from being adversely affected by market conditions that can impact your returns.
Though it’s important to be aware that, although real estate and stocks aren’t highly correlated, various categories of real estate can perform better than others for multiple reasons. As a result, your real estate investment can still underperform if the type of real estate you’ve invested in is in a slump.
For example, New Residential Investment Corporation (ticker: NRZ) is a mortgage REIT that became one of the worst-performing investments in 2020, primarily due to the Coronavirus pandemic. NRZ had a great start to 2020, but, once Covid took hold, NRZ ended the year at over -38%.
This brings us to a few of the risks you should be aware of when investing in REITs:
Risks Of Investing In Residential REITs
Residential REITs can generate decent returns over the long term, but like any investment, they aren’t without their risks.
Some risks of investing in a residential REIT include:
- Oversupply risk: There’s always the chance that the development of new properties exceeds the demand for those properties. If there is more supply than demand, rental prices decrease.
- Financing risk: Most REITs use leverage or debt to acquire new properties. Rising levels of debt can add considerable financial risk. If not careful, the REIT’s debt could exceed its ability to repay, and it may need to liquidate assets or cut dividends to cover costs.
- Interest rate risk: Rising interest rates often result in a downturn in demand for REITs. When interest rates rise, investors generally prefer safer investments, like US Treasury bonds.
4 Things To Keep In Mind When Picking REITs
There are several factors to consider before investing in residential REITs:
1. Check the market
The best markets tend to be in areas with low affordability compared to the rest of the country. In cities like San Francisco and New York, where the high cost of property forces most people to rent, landlords can charge higher rents each month.
For example, Equity Residential is a publicly traded REIT and the largest apartment REIT in the US, with a market capitalization of $28.4 billion. It primarily targets New York, San Francisco, Washington D.C., Boston, Seattle, and Southern California. Many other multifamily REITs will target similar areas.
Alternatively, others will target more affordable housing to generate better returns over the long term through the higher growth potential of these markets.
2. Consider population and job growth
When assessing which residential REIT to invest in, two criteria to keep an eye on include population and job growth.
Generally, when people start migrating to a city, jobs are available, and the economy is performing well. If there are declining vacancy rates with rising rent prices, it typically means that demand is improving.
As a rule of thumb, as long as the supply of residential properties remains relatively low and the demand remains high, residential REITs should offer dependable returns.
Most REITs don’t meet the IRS’ definition of “qualified dividends.” As a result, the above-average dividends REITs can provide are often subject to higher tax rates than most other dividends.
Depending on your tax bracket, the tax rate for qualified dividends is 0%, 15%, or 20%. However, since the IRS sees most REIT dividends as ordinary income, your realty income is subject to the maximum ordinary income rate of 37%.
4. Investment timeline
It’s also important to consider that REITs are a long-term investment. Investors can benefit from high dividends and solid long-term appreciation, but understand that these returns will take time. One key factor to consider before investing in a REIT is its historical performance.
While there’s no one-size-fits-all approach to how long you should hold your real estate investment, it’s usually a good idea to hold your REIT investment for at least five years.
To maximize your benefits over this period, it’s always worth doing your research to find a REIT with a history of reliable dividend payouts with good value appreciation.
Taking that into account, here are a couple of excellent residential REITs you could consider investing in:
2 Great Residential REITs To Invest In
If you’ve decided that a residential REIT sounds like a worthwhile investment, consider these two offerings:
DiversyFund is a public, non traded REIT providing investors with access to multifamily real estate properties. DiversyFund is vertically integrated, meaning the REIT buys, renovates, rents out, and manages all properties, effectively reducing fees.
Investors saw an average annualized return of 17.3% in 2018, which DiversyFund hopes to maintain.
There are no fees charged to investors.
2. Upside Avenue
Upside Avenue is a multi-housing income REIT specializing in purchasing and renovating multifamily housing in and around Texas. Upside Avenue’s parent company, Casoro Group, manages the REIT, sources properties, and handles the construction and operations of the properties.
Upside Avenue targets annualized returns of 10-15%.
There’s a 2% annualized asset management fee, and Upside Avenue charges a 2% disposition fee when a property is sold, based on the property’s value.
Residential REITs are fantastic investment opportunities, offering potentially above-average returns, portfolio diversification, and passive income generation.
However, keep in mind that real estate is an inherently long-term investment. If you’re investing in residential REITs, be prepared to hold your investment for at least five years. It’s also worth making sure the REIT targets large urban areas to maximize returns.
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