REITs In Real Estate Investing: Their Risks & Benefits

REIT Investing: How They Work And Their Advantages + Risks

The world of real estate investing is full of potential and opportunity, and there are so many ways to get in the game. At Leadflow, our lead generation software helps everyday people identify the best off-market properties, analyze markets and grow their wealth through property ownership.

But real estate investment trusts, or REITs, are another avenue people can use to get into the real estate market without needing to buy and manage properties themselves. 

While direct property ownership is often more profitable and scalable, for those that want to get a taste for what the real estate market can do - there’s REITs.

3 Strong Reasons Why REIT Investing May Be Right For You

1. The Potential For High Returns

The potential for large dividends is one of the primary advantages of investing in REITs. REITs are required to return at least 90% of their taxable income to shareholders, making them an excellent choice for investors who seek consistent income.

Dividends are payments made by the REIT to its shareholders, often on a quarterly basis, and can provide investors with a consistent stream of income. Additionally, REITs with a history of consistent or increasing dividends may be appealing to investors seeking potential long-term gain.

2. A More Diverse Investing Portfolio

REITs can help diversify a portfolio because their success is not always directly related to the stock market. Interest rates, economic conditions, and demographic shifts can all have an impact on real estate markets.

This can make REIT returns less associated with typical stock and bond returns, which can help lower total portfolio risk. Diversifying your portfolio with real estate investment trusts (REITs) might assist to lessen the impact of market swings and potentially generate superior risk-adjusted returns.

3. It’s Relatively Easy to Invest In

REIT investing is relatively simple, as investors have a variety of options to pick from. Investing in REIT index funds or ETFs, which provide exposure to a diverse variety of REITs, is one option. This can give investors diversification and ease of management.

Investors can also investigate and invest in individual REITs that operate in a specific industry or geographic location.

An investor, for example, may decide to invest in a REIT that specializes in office buildings in a given city or region. This can provide a more targeted investing strategy with the potential for higher returns, but it also carries a higher level of risk.

The Risks Of Investing In REITs

However, it's important to remember that, like all investments, REITs do come with risks. 

1. Market Risk

Changes in the real estate market might have an impact on the value of REITs. If the market suffers a downturn, the value of REITs' properties may fall, causing the value of their shares to fall. As we saw at the start of COVID, the real estate market can be affected significantly more than other stocks in a global event like that. 

Furthermore, rising interest rates might make borrowing money more expensive for REITs, severely impacting their performance.

2. Interest Rate Risk

REITs are particularly susceptible to fluctuations in interest rates since they often have higher levels of debt than other corporations. When interest rates rise, the cost of borrowing money rises, reducing the REIT's net income.

This can result in a significant drop in the value of the REIT's shares.

3. Risk Of Being Overleveraged

Many REITs are highly leveraged, meaning they have a significant amount of debt compared to their equity. This can magnify potential losses during a market downturn, as the REIT may not be able to meet its debt obligations.

4. Risk Of Low Occupancy

REITs create revenue by renting out their buildings. If a REIT's properties have a high vacancy rate, this can reduce income and have a negative impact on performance.

5. Management Risk

REITs are managed by a team of professionals; yet, management's ability to make wise judgments and execute their strategy can have an impact on the REIT's profitability.

Furthermore, a REIT that is reliant on a small number of properties or tenants may be more vulnerable to the risks associated with a single tenant or property.

Real-World Example Of An REIT

Empire State Realty Trust (ESRT): 2020

Empire State Realty Trust (ESRT) is a real estate investment trust (REIT) that owns and runs New York City office and retail facilities, including the landmark Empire State Building. Due to the COVID-19 pandemic, the corporation experienced significant issues in 2020, as several of its locations were shuttered or operating at reduced capacity. Furthermore, several of its tenants struggled to pay their rent, resulting in a decline in revenue for the REIT.

However, Empire State Realty Trust was able to overcome these obstacles and continue to pay dividends to stockholders throughout the year. By decreasing staff and renegotiating leasing arrangements with tenants, the company was able to cut costs and remain afloat. Furthermore, the company was able to find new tenants and extend leases for a number of its properties. As a result, the company's stock price recovered by the end of the year, though it was still lower than pre-pandemic levels.

This example demonstrates how the economic slowdown induced by the pandemic can damage even a well-established and prominent REIT like Empire State Realty Trust. The capacity of the company's management team to adapt and make solid judgments helped the company weather the storm; but, stock price performance was impacted. This emphasizes the need of taking into account the management team, as well as the company's financials and strategy, before investing in a REIT.

If you’re looking to dip your toes into the real estate investing market, REIT investing is a great way to do that. But if you’re looking to level up your real estate investing game through lead generation and market analysis, check out Leadflow’s tool suite with this 7-day free trial below!