Alternative Investing: How to Invest in REITs

Long before the stock market existed, investors focused on land. After all, as the old saying goes, they're not making any more of it. There's also a limit to what people can put on land (houses, skyscrapers, shopping malls) and get out of it (grain, gold, oil, wood).

Real estate investment trusts (REITs) first emerged in the 1960s as a way for individual investors to gain exposure to real estate. For many years, they remained relatively under the radar. More recently, however, some investors have turned to REITs for diversification, potential inflation protection, and income generation.

At a basic level, an equity REIT is a company that owns income-producing properties, such as apartment buildings or commercial strip malls. Shares of REITs often, although not always, trade on major exchanges.

This article outlines the basics of REIT investing, including potential benefits, historical performance, and key market sectors such as healthcare, retail, residential, and infrastructure.

Many REITs are registered with the SEC, and some trade publicly like other stocks. This gives investors the option to diversify by investing in real estate while maintaining liquidity, rather than directly owning physical property. In the United States, the IRS requires the trusts to distribute 90% of their taxable income annually. As a result, they may offer higher dividends than stocks or bonds, making them a potential source of income.

Additionally, when inflation is rising, REITs may potentially act as a hedge because property values and rental income tend to rise alongside the cost of living.

Lease lengths can influence how cyclical a property type is. For example, office properties, with their long lease terms, tend to be more pro-cyclical. When businesses are growing and adding more people to support that growth, they are likely to lease more space. When growth is more challenging, fewer businesses will look to expand their office footprint and may instead be shrinking. REITs may not involve all the risks of the stock market, but they do involve the risks of the real estate markets. While this can have a diversifying effect, it does not eliminate, and may not even reduce, the risks of investing.

The REIT market can see periods of outperformance versus the broader stock market. However, the sector can also see periods of intense volatility. For example, in the early 2000s (a period which many called a real estate bubble), the Dow Jones Composite All REIT Index ($REI) outperformed the S&P 500^® Index, but the sector was hit particularly hard during the ensuing financial crisis in 2008–09. 

When the U.S. Federal Reserve starts hiking interest rates, the market can sometimes start to look bearish for REITs, as rising rates can mean higher borrowing costs. REITs tend to benefit from economic growth, which supports rent collections and property prices. However, most REITs borrow heavily, making them extremely vulnerable to rising interest rates.

Retail and office REITs: These partnerships own and manage properties such as shopping malls, office buildings, strip malls, and big-box stores, and lease those properties to tenants.

Healthcare REITs: These REITs invest in properties such as senior living facilities, hospitals, medical office buildings, and skilled nursing facilities.

Residential REITs: These REITs own and manage a wide range of housing properties, including multifamily apartments, duplexes, student housing, and single-family residences.

E-commerce-related REITs: Taken together, data center, industrial, and infrastructure categories form a synergistic "triad" for the e-commerce economy. Infrastructure REITs may include cell towers used to relay e-commerce orders, while industrial REITs often include warehouse distribution and logistics facilities for e-commerce goods, and data center REITs store and manage facilities.