What is a REIT?
Updated
August 28, 2024
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We explain the ins and outs of one of the most popular routes to real estate investing.
Buying real estate is expensive. Even if you live outside of a major city, the odds are a house purchase is going to be one of the priciest things you purchase during your life.
And for the average person, investing in real estate by buying physical buildings is a very tricky thing to do. Yes some people might rent out a second home but buying offices or retail stores is simply not within the grasp of the average person.
That’s why real estate investment trusts — or ‘REITs’ for short — are a popular way of investing in property. Just as you wouldn’t try to invest in Facebook by buying the whole company, REITs let you buy shares representing a small holding in a larger property portfolio.
A real estate investment trust is a company that invests in different types of real estate. That could include everything from flats people live in to data centres used by technology companies.
Owning shares in a real estate investment trust is a means by which you can invest in those properties. And because those shares aren’t going to cost you hundreds of thousands of pounds, they’re also a cheaper way to do it.
Lots of international stock markets offer REITs and each one will have their own laws governing them. As a result, and even if they look similar, the way REITs operate varies from country to country, so you should check any local laws before investing in them.
On a practical level REITs work in much the same way stocks do. Shares in REITs are usually listed on exchanges and can be traded by market participants.
The difference usually lies in the regulations that govern them.
In the UK, REITs are governed by quite a specific set of rules that do have an impact on your investments, so it pays to be aware of them.
Qualifying as a REIT in the UK means adhering to a range of regulations. Some of the major ones include:
UK REITs offer a number of advantages to investors and there are a range of reasons why people buy shares in them.
REITs carry risks with them, just like any other asset class. Before investing you should understand the investment risks that come with them. That includes:
REITs vary massively in terms of the properties they invest in. As a result, investors tend to separate REITs into different categories. Sometimes there can be overlap but generally REITs have a specific goal in mind and only belong to one category.
Equity REITs buy properties and derive their income from renting them out. That could include housing, offices or commercial warehouses.
A mortgage REIT provides funding for properties and receives money in the form of interest. So they’ll provide cash to someone building something like an office block and receive interest payments on the money they’ve lent.
Alternatively they might buy mortgage-backed securities. A bank might fund a property project and then turn that mortgage into a product that can be invested in. Some mortgage REITs also invest in these products.
As their name suggests, residential REITs invest in properties that people live in. That could include houses but also apartment blocks or student accommodation.
Some residential REITs include:
Retail REITs focus on investing in retail outlets. That could include things like shopping centres or high street real estate.
Some retail REITs include:
Healthcare REITs invest in properties that are used by healthcare professionals. That could include hospitals, surgeries or care homes.
Some healthcare REITs include:
It may seem niche but there are actually lots of REITs that operate or lease self-storage facilities.
Some self-storage REITs include:
These may also seem like a niche investment to make but there are lots of REITs that invest in data centres.
Some data centre REITs include:
Infrastructure REITs have a broad remit. They invest in the sorts of things we need to keep our economy running. That might include energy facilities, transport systems or water works.
Some infrastructure REITs include:
Hotel and hospitality REITs invest in holiday and leisure properties. That might mean having holdings in amusement parks, hotels or casinos.
Some hotel and hospitality REITs include:
As they can invest in such a wide spectrum of assets, REITs diverge substantially in the returns they have historically provided
Even REITs active in the same sector, say healthcare, will produce vastly different returns because of other factors, like the people managing the trust, the location of their properties and geographical differences.
UK REITs are exempt from paying corporation tax on rental income. This is good because it means there is more income for the company to distribute to shareholders.
But you still have to pay tax on that investment income. Distributions from REITs are called property income distributions (PIDs).
PIDs are taxed at source at 20%, the current basic income tax level. If you pay a higher band of income tax then you could be liable to pay more.
REIT tax is complex and involves a lot of nuances, so if you want to get to grips with the finite details of the subject then be sure to do some thorough research.
Be aware that REITs are also treated differently from country to country, so UK REITs are not treated the same as US ones. Any rules governing them are likely to impact your return on investment, so make sure you’re aware of them.
As REITs invest in such a broad range of real estate, you can’t really say they’ll all respond in the same way to rises or falls in interest rates.
But in general, lower rates do appear to have benefitted REITs. One study undertaken by credit rating agency S&P Global Ratings found that US REITs tended to yield higher returns when there were lower interest rates.
Part of the reason for that is lower rates allow more people to borrow and thus build more property. That would potentially lead to REITs finding it cheaper to borrow money to invest in projects as well.
The thing is, stocks have also performed well in a low interest rate environment. And as we’ve said already, REITs have such a broad remit that there were bound to be other factors at play there as well.
As with other asset classes, it’s good to be aware of how investments and interest rates interact but you shouldn’t invest in REITs based solely upon that relationship.
Most investors want to know two things about REITS when comparing them to the wider stock market.
The first is if they are safer. The answer is that they aren’t any more or less safe. As we’ve seen already, REITs invest in a wide range of properties.
And just as there are a wide range of companies with different risks attached to them, the risk associated with an individual REIT will depend on its own characteristics, including the things it invests in and the people managing it.
Lots of investors also want to compare the returns REITs provide to stocks. The overall picture here is actually negative.
Research from investment bank Numis found that UK-listed REITs underperformed the total return of the UK's largest 100 listed companies in the decade ending in January 2020. But again, individual REITs invest in unique things and most investors buy shares in them as such, not as a group.
The experience of investing in REITs is pretty much the same as one you’d have investing in shares.
As they’re exchange-traded, you simply buy shares in them via your brokerage account (see how to open an investment account).
That can be in a general investment account or, if they’re permitted, in a stocks and shares ISA or SIPP pension account.
Investors like to have black and white answers to questions like this. Sadly they’re rarely forthcoming (have a read of our ‘how to start investing in stocks’ guide if you want to learn more about why that is).
REITs could be a way of diversifying your portfolio and, if you are attempting to do that, they would just be one of many different assets that you put money into
But there’s no hard and fast rule here. It would likely be a mistake to put all of your money into REITs as you could just end up being heavily exposed to a particular part of the real estate sector.
At the same time, you may find no REITs that you think are investment worthy. In that case you shouldn’t just be buying them for the sake of it
So the answer here is to treat REITs much like you would any other asset class. Don’t overexpose yourself to them and if you don’t think they’ll make a good investment then don’t buy them.
Like stocks, there are lots of different data points to consider when investing in REITs.
The key thing to remember here is that some common metrics, notably earnings per share and price to earnings ratios, don’t work that well when applied to REITs.
Here are some other things that you can look at instead.
Investors often find a high dividend appealing but it’s not always the best place to start.
Dividend yields are often based on the last dividend payout as a percentage of the REIT’s current share price.
That means yields rise as share prices fall. So a higher dividend may actually be a sign that a REIT is not performing well, which is obviously something to be wary of.
Hunting for the biggest dividends is thus not necessarily the best thing to do. You also have to look at some of the valuation metrics we just mentioned and figure out if it’s a good business to invest in.
You can calculate the dividend yield on REITs in a couple of ways.
Both of these options are used by analysts and data providers. If you are looking at data online or from any other source it’s worth knowing which method is being used, so as not to be misled.
You can calculate the payout ratio for REITs in a couple of ways.
Again, both methods can be used by analysts, so if you are looking at data from a third-party source then make sure you know what you’re really being told.
REITs may not be the most trade shares or as popular as some big name stocks but lots of Freetrade customers still buy them. Here are five of the most bought REIT stocks on the app.
REITs are exchange-traded and close end, meaning only a set number of shares can be issued by the company.
In contrast, real estate mutual funds are not exchange-traded and are open ended, meaning more shares are issued as more people buy into the fund.
Research from investment bank Numis found that UK-listed REITs underperformed the UK 100 for the decade ending in January 2020.
But each REIT is different and the assets they invest in vary massively, so their worthiness as investments will depend on those unique factors, as opposed to the characteristics they share with other REITs.
Debts are an expense and thus paid out of company revenues, not net income. It is the net income that is distributed to shareholders. That means any necessary debt payments are made before income is distributed to shareholders.
It is certainly easier because REITs tend to be cheaper and much more liquid than physical properties.
But you may buy a house to live in or for your children, which REITs obviously cannot offer.
Ultimately, you can’t really say that it’s ‘better’ to buy real estate or a REIT because it depends on what your goals are.
The amount a REIT pays out will depend on how profitable it is. Just because a REIT has to payout 90% of earnings, doesn’t mean its earnings will be high. And if they’re not then it’s going to mean it has a poor payout ratio.
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