REITs; 7 Reasons why REITs are Great at Making Passive Income
Here we get to look at what REITs really are and how you can make a recurring income passively from owning such an investment as well as why they are the perfect invest for this type of income.
What is a REIT?
A real estate
investment trust is a company that owns or manages real estate for income
generation. Most REITs focus on buying and renting out real estate for income
generation while some REITs focus on mortgages and mortgage backed securities
for the same reason.
Important for
noting is that REITs, as highlighted in the definition, own the properties
which means by investing in a REIT you become part owner of those properties in
the same way investing in a company’s stock makes you part owner of that
company. Because the company manages and maintains the properties, there isn’t
much to do on your part but to cash in from your investment possibly making
REITs the most passive real estate investment you can ever make.
Before we look
at how you can invest in a REIT, let’s look at some of the requirements that a
company has to meet to qualify as a REIT.
- 95% of its income must be passive
- No less than 5 individuals are to own more than half of the company’s shares
- It’s to have no less than 100 shareholders
How REITs Work
A REIT buys,
manages and rents out property for income generation on behalf of its
investors. The income earned is then distributed to the company’s shareholders
(that’s you) as dividends. Individual investors (you again) pool money which
allows you to own a percentage of the business or properties owned by the REIT.
Some of this property is commercial or retail real estate which is almost
impossible for the average individual to be able to invest in without REITs.
This is the great thing about REITs; they allow you to invest in properties
that would otherwise be impossible to invest in individually.
The process is a
pretty simple and straightforward one; you the investor together with other investors
buy shares from a REIT. This makes you part owner of some of the REIT’s
property.
The money that
you invest is put into good use by the company, usually as capital to fund the
company’s projects.
In return, the company
rewards you for being a shareholder by paying you in the form of dividends from
the income they generate from their rental properties.
How to Start Investing
To invest in a
REIT you need to do so through a mutual fund or an ETF (Exchange-Traded Funds).
Buying shares through an ETF requires a minimum investment of $3 000 for
most of the reputable REITs.
An alternative
to ETFs and mutual funds is investing in a eREIT. These are publicly traded and
require less capital to start. Fundraise offers such a service and you only
$500 to begin.
Types of REITs
There are two
types of REITs; Equity REITs and Mortgage REITs. Under these two are
specializations depending on the type of property in which a REIT invests in,
for example there are retail REITs and commercial REITs. These are sometimes
referred to as types of REITs in some cases.
1. Equity
REITs
The
majority of REITs are equity trusts and they constitute about 90% of all REITs.
They buy and own rental real estate and sometimes sell real estate for profit.
However they mainly get their income from rental income.
They
often specialize in a specific type of property. For example there are retail
REITs that own retail properties like shopping malls while office REITs invest
in office buildings. Here is a list of the popular types of real estate
property REITs specialize in.
- Retail – Shopping malls and hotels
- Residential – Apartment buildings and houses
- Office – Cooperate buildings and office space
- Healthcare
– Hospitals, Medical centres, Retirement houses
2. Mortgage
REITs
These
buy mortgages or mortgage backed securities or they lend money to real estate
buyers. Mortgage REITs make money from the interest on mortgage loans. They
also specialize like equity REITs, for example a REIT can focus entirely on residential
mortgages or on healthcare mortgages.
7 Reasons why REITs are Great for Passive Income
1. 100% Hands Off
REITs are one of
the few investments that don’t need any form of input once you invest. This
plus the fact that they pay out dividends monthly makes them perfect for passive
income.
The majority of
passive income streams still require some form of work on your part from time
to time, sometimes once or more weekly or monthly. It doesn’t make them any
less passive but they do need a bit of input to make them work.
2. Low Costs
REITs are less
capital intensive compared to other real estate investments like rental
properties. Most REITs require a minimum of $3 000 to invest while eREITs need
much less. When you compare that to buying rental property and paying mortgage,
it’s a low starting cost.
Buying a decent
rental property for example often requires a down payment of about $10 000.
The difference there is quite significant.
REITs are also
great because they make investing in real estate possible even for those who
don’t own properties of their own. A lot of people pay rentals because they don’t
own houses. Buying a rental property when you don’t own a house of your own is
impractical to say the least. But thanks to REITs, you can invest in real
estate even when you can’t afford to buy a house of your own.
3. Leverage
Investing in a
REIT gives you the leverage to own properties that you would otherwise never
own on your own. REITs own dozens of big commercial properties that individual
investors cannot afford to invest in. Individual investors often invest in
residential real estate because it’s more affordable.
But with REITs
you get the leverage to invest in larger properties. Investing in a medical
REIT means you are part owner of hospitals and medical centres and investing in
one that specializes in retail property means owning shopping malls which is
near impossible if you’re on your own.
The type of
property in which you invest can sometimes be the difference between a higher
and a lower return.
4. Diversification
REITs provide a
diversified investment portfolio for their investors by owning dozens of
properties in different areas. Sometimes these different areas are as wide as national
or even continental borders. When one or more properties are not being profitable,
other properties will cover for the shortfall.
This gives REIT
investors an edge over individual rental property owners because they literally
have a portfolio of dozens of properties which is great for reducing risk.
5. Liquidity
Real estate
properties are not liquid which is can be problematic for investors but REITs don’t
have that problem. REITs sell shares on the stock market which means they can
be sold or bought at the click of a mouse.
You don’t have
to worry about transaction costs either, REITs have lower transaction costs
compared to other real estate transactions because they don’t have commissions
and hidden fees included.
6. Professional Management
More than half
of people investing in real estate for the first time buy rental property and
manage their investment on a ‘learn as you go’ basis. This is with zero formal
property management training and a limited informal knowledge of how real
estate is run. This can be a risky approach to investing which oftentimes leads
to loses and frustration.
REITs have an
easy solution to that problem. REITs are big companies and it goes without
saying that they are run by experienced professionals who know how to handle
problems and increase profitability in real estate.
This is great
not only for the risk management and profitability of your investment, but it
also ensures that your income is completely passive.
7. Income Growth
REITs can grow
your income quicker than private rental property can. REITs often have more
capital to work on new projects for expansion and growth. This also means the
growth of your income and investment as a whole.
The more the
properties the company buys the higher your potential income and not only that
but the more the company’s share price increases. If you were to sell your
shares you would make a profit from your investment.
With private
property ownership the growth is slow due to a lack of capital and liquidity
issues.
Conclusion
It shouldn’t
take much to realize how important it is to have a REIT as a part of your
investment portfolio when you invest for passive income. It’s completely
passive with high income and growth. It’s also a secure, liquid and diversified
investment. REITs are nothing short of a dream passive income stream.
Dream Passive Income does not give financial, tax or investment services and advice. All the information you see here is produced and presented with no consideration of the readers risk tolerance, financial circumstances and objectives. The information might not be suitable for all readers and or investors. Past performance is not indicative of future results. Investing involves risk and possible losses.
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