Real estate investment trusts — REITs — are essentially mutual funds that buy real estate instead of stocks. While some experts argue that REITs provide portfolio diversification and are a great way to derive passive income, there are also a slew of misconceptions around them.
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What Are REITs, and How Can They Create Wealth and Financial Security?
Real estate investment trusts (REITs) offer a way for people to invest in real estate without directly taking on all the risks and complexities of owning property, said Dutch Mendenhall, CEO and co-founder of RADD Companies.
According to him, they are worth considering for several reasons. First, he said, REITs are typically run by real estate professionals, so you’re likely to make more informed investment decisions and experience less risk.
They also generate income through rent and property appreciation, so you can get steady cash. In addition, he added that they have a lower investment threshold.
“With REITs, you can invest in large-scale, institutional-quality real estate with a smaller upfront investment than you’d need for direct real estate investments,” he said. “Overall, REITs offer a way for people to get a piece of the real estate pie while avoiding some of the risks and headaches that come with owning property directly.”
Yet, several myths about REITs are preventing investors from adding these to their portfolios.
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Myth: REITs Are Illiquid
Some people assume REITs could take the same time and effort to sell that a direct real estate investment could take.
“But because most REITs are publicly traded, they’re just as simple to sell as any other stock,” said Todd Stearn, founder and CEO of The Money Manual. “One exception is public non-traded REITs, but these are not listed on exchanges and aren’t what most new REIT investors will be buying anyway.”
Cliff Ambrose, FRC, founder and wealth manager at Apex Wealth, echoed this sentiment. He said that while REITs may not offer the same level of liquidity as stocks, they are traded on major stock exchanges, allowing investors to buy and sell shares relatively easily compared to direct real estate investments.
“Recognizing this level of liquidity can reshape investors’ perceptions and highlight the accessibility of REITs within a diversified portfolio,” Ambrose added.
Myth: REITs Are Concentrated
Another assumption is that each REIT is highly concentrated in a specific niche of real estate.
While some certainly are, Stearn said, there are also plenty of REITs that own property in a variety of sectors.
“It’s also a good idea to diversify your REIT holdings, just like you diversify the rest of your portfolio,” he continued. “So investing in REITs in several different sectors that you believe in the future of can be a great strategy.”
For instance, you might choose to invest in retail REITs, senior living REITs, industrial REITs and farmland REITs.
“Each of those options could be pretty concentrated, but you’d be keeping your overall REIT holdings diverse,” added Stearn.
Myth: REITs Are Highly Correlated to Stocks and More Volatile Than Physical Real Estate
According to Robert R. Johnson — professor of finance at the Heider College of Business, Creighton University — while the returns to most stocks are highly correlated, the correlation of returns to REITs and broader stock market indexes is much lower.
“Research shows that REITs do provide substantial diversification benefits. According to data compiled by Ibbotson Associates, from 1972 through 2017, the annual correlation between equity REITs and the S&P 500 was 0.54,” he added.
And in terms of their volatility, because REITs are publicly traded, there is an active market for the shares in a REIT — and people can watch the value of their holdings go up and down minute by the minute.
“When one purchases a physical piece of real estate, since there is not an active market for the property, one can believe that the value is stable,” said Johnson. “Of course, this is illusory. Just because there isn’t an active market for an asset does not mean the underlying value of that asset doesn’t fluctuate.”
Myth: I Don’t Need To Invest in REITs Because I Already Own a Home
Home ownership is different from owning and benefiting from commercial real estate investments. Historically, the average financial return of home ownership has been quite low compared to owning REITs, said Abby McCarthy, SVP of investment affairs for Nareit.
“They offer investors a steady stream of high dividends, liquidity, transparency, and competitive returns,” she said. “In addition, they offer property and geographic diversification because REITs offer exposure to a wide range of properties across the United States. Home ownership does not offer that type of diversification because a house is only on one block in one neighborhood in one city in one state.”
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This article originally appeared on GOBankingRates.com: 4 Myths About REITs: What To Know Before Investing
