Real estate investing has long been considered a reliable way to attempt to build wealth. However, real estate investing requires active management, driving away many of today’s accredited investors. In 1960, a solution to this problem was presented in the form of real estate investment trusts, or REITs – Congress established REITs to “allow individual investors to invest in large-scale, income-producing real estate. REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy commercial real estate.”

Since the introduction of REITs, the industry has been booming. National Real Estate Investor recently reported, “The U.S. alone boasts 222 publicly-traded REITs, and IRS records show that about 1,100 listed and non-listed REITs pay taxes. … REITs now operate in 39 countries overall. Today, the market cap of the FTSE Nareit All REITs Index, the broadest index for equity and mortgage REITs in the U.S., stands at $1.1 trillion.”

The question now is, how can one seek to build wealth through REITs? To understand the answer, let’s look at some primary concepts related to REITs, their historical returns, and the process for investing in REITs.

What is a REIT?

A REIT is a company that owns and operates income-producing real estate and real estate-related assets. REITs differ from other real estate funds in their structure and operation. Regarding operational intent, REITs acquire and develop real estate properties for their portfolios; their intent is not to buy and sell for a profit but rather to work to benefit from a long-hold period with the real estate.

Types of REITs

REITs can be broken into three categories:

1. Equity REITs own and operate income-producing real estate.
2. Mortgage REITs provide money to real estate owners and operators either directly in the form of mortgages or other real estate loans or indirectly through acquiring mortgage-backed securities.
3. Hybrid REITs are companies that use the investment strategies of both equity REITs and mortgage REITs.

Generally, individual investors looking to build or preserve wealth invest in equity REITs over mortgage REITs because the latter often comes with greater risk. For example, mortgage REITs tend to be highly leveraged and, consequently, are vulnerable to changing interest rates. Therefore, those hoping to enjoy the benefits potentially provided by a REIT should consider an equity REIT option.

Seeking to Build Wealth Through REITs

REITs offer various potential avenues investors can leverage to attempt to build wealth. Here are a few.

• Dividend income. Purchasing shares of a REIT may provide investors access to dividend income, which is income paid to shareholders out of the profits of the corporation. Equity REITs derive their income from the collection of rental income. Per law, at least 90 percent of a REITs taxable income must be distributed to shareholders annually as dividends. Generally, investors opt to reinvest their dividends instead of withdrawing cash. This allows them to build equity in a REIT and preserve capital – dividend reinvestment is automatic and does not require an investor to pay any commissions; therefore, more capital can be invested.
• Inflation hedging. Real estate is one of the few investments that offer a potential hedge against inflation – in other words, it seeks to protect investors against a decrease in the purchasing power of money. Over the past ten years (2011-2021), the inflation rate has averaged 2.01 percent. Most real estate assets include a rental increase, allowing real estate values to increase as inflation occurs. Traditional investments such as stocks and bonds do not have this characteristic.
• Long-term capital appreciation. REITs, like real property investments, offer long-term capital appreciation potential. Over time, real estate values generally increase, and, as a result, an investor’s equity in the trust increases as well. If a REIT purchases real estate and holds the property in its portfolio for more than a year, individual investors are then taxed based on the long term capital gains rate. This rate is generally lower than the short-term capital gains and income tax rates.
• Historically higher returns compared to equities. The Motley Fool recently shared an analysis that compared equity performance to REIT performance. Data showed that, generally, REITs have outpaced the S&P 500’s total return, according to NAREIT (1) . Over the last 25 years, the S&P total annual return averaged 12.1 percent, while the FTSE NAREIT All Equity REITs total return averaged 13.3 percent.
• Possibility of preservation of wealth through diversification. Most REITs consist of hundreds of properties that span the country, thereby creating diversity within the trust. Purchasing a single asset, on the other hand, offers no diversity. Investors who own direct real estate must invest exponentially more capital to get similar diversity, although this is rarely achieved since REIT portfolios can contain billions of dollars in real estate. This diversification enables investors to seek to preserve wealth during economic uncertainty. For example, if one market declines, another market may improve, offsetting an investor’s losses.
• Pass-through deductions. Until 2025, individual REIT shareholders can deduct 20 percent of their taxable REIT dividend income (excluding dividends that qualify for capital gains rates). This provision, which currently has no cap on the deduction, no wage restriction, and no requirement for itemized deductions, effectively lowers the federal tax rate on ordinary REIT dividends. Most significantly, investors in the highest tax bracket can leverage this provision to reduce their tax rate from 37 percent to 29.6 percent.

Which REITs should one consider investing in?

REITs can be categorized in various ways, and most of today’s REITs specialize in investments in certain asset classes. For example, there are retail REITs, office REITs, residential REITs, healthcare REITs, and industrial REITs, to name a few. While each offers a different level of return potential, recent data from Motley Fool outlines how various REIT subgroups performed in recent decades compared to the S&P 500; it shows that all REIT subgroups have outperformed the S&P 500. The S&P 500 experienced a 9.3 percent average annual total return between 1994 and 2019. In contrast, office REITs averaged 12.9 percent; industrial REITs averaged 14.1 percent; retail REITs averaged 12 percent; residential REITs averaged 13.7 percent; diversified REITs averaged 9.8 percent; health care REITs averaged 13.4 percent; lodging/resort REITs averaged 10.2 percent; and self-storage REITs averaged 16.7 percent.

Thus, most REITs have the potential to help investors build wealth.

How does one invest in a REIT?

Investors – depending on their financial position – have three options for investing in REITs.

All investors can invest in publicly traded REITs and publicly non-traded REITs. Publicly traded REITs are regulated by the U.S. Securities and Exchange Commission (SEC); shares of these REITs are listed on a national securities exchange and publicly traded. Non-traded REITs are also registered with the SEC but are not publicly available. Rather, most investors must work with an individual broker or financial advisor.

While public non-traded REITs generally come with higher commissions and are less liquid, they tend to offer investors the potential for higher returns and greater stability since they are not subject to market fluctuations. However, this comes with increased risk, as well.

A third option – private REITs – are generally available only to institutions or accredited investors. This option typically represents the highest potential for both returns and risk.

Today, hundreds of REITs collectively own trillions in gross assets across the United States. Identifying which REIT is most suitable for a portfolio is best done by speaking with a qualified professional about today’s investment opportunities.

(1) The National Association of Real Estate Investment Trusts (NAREIT), which was formed in 1960, has been keeping track of historical return data for the REIT sector since 1972. It has developed several indexes to track returns, led by the FTSE NAREIT All Equity REIT Index. This index contains all 12 equity REIT subsectors (it excludes mortgage REITs, which aren’t classified in the real estate sector but are instead considered financial companies).