Commercial real estate can be a great opportunity for investors but there are certain aspects that can seem like too much trouble for those without the proper resources. Most notably, commercial real estate is much more complex and expensive than residential real estate. But there is a way for more modest investors to get involved with commercial real estate; real estate investment trusts (REITs).

What is a REIT?

Created by congress in 1960 and modeled after mutual funds, a REIT is a company that owns or finances real estate that produces income. Required by law, these real estate trusts invest in several different types of real estate and allow just about anyone to invest in a variety of commercial real estate options. Which REIT an investor invests with depends on what type of properties the REIT specializes in.

The biggest advantage for modest investors that have interest in investing in commercial real estate is that REITs get rid of the complexity and expensiveness of purchasing commercial real estate. It is also a great opportunity for these investors to diversify their portfolio. The law requires that REITs must be widely held and most of the income must be distributed as dividends to the shareholders. Due to the fact that investors are able to purchase shares on the stock market, REITs are considered very liquid assets which may be desirable to someone that is less comfortable with a commercial real estate commitment.

By having the ability to expand their real estate investment portfolio, these modest investors are able to gain significantly more real estate exposure than they would be able to generate on their own. It also allows them to have instant liquidity, something they would likely not have if they acquired commercial real estate on their own.

Types of REITs

There are two main types of REITs that someone can invest in; equity REIT and mortgage REIT. Depending on which type of REIT the investor is investing in, they will either be investing in the equity financing or in the debt financing of a real estate property.

Equity REIT

Equity REITs consists of real estate companies that acquire commercial properties with the intent on leasing the space to tenants. They then disperse the income collected, after taking out expenses, to shareholders as dividends. Included in the dividends is any capital appreciation from the sale of a property. The idea of dispersing dividends is intended to approximate the amount that the investors would have earned had they owned the property themselves.

Equity REITs make up about 90 percent of all market capitalization, which is to say, the total amount of the market value of a company’s outstanding shares. The way these REITs work is that investors that take part in the REIT pool their money together which is then provided to the REITs management team who buys the type of property that the specific REIT specializes in. That income from that investment is then distributed as dividends to those investors from income and any capital appreciation from the sale of the property.

Mortgage REIT

Mortgage REITs are where investors invest in real estate mortgages or mortgage-backed securities, usually single-family home loans. They then earn income from the interest of these investments and from the sale of the mortgages. Mortgage REITs have some of the same requirements as equity REITs in that they must distribute a bulk of their income to their shareholders annually.

What Should You Expect from a REIT?

Whether an investor decides to invest in an equity REIT or a mortgage REIT depends on that investor’s long-term investment goals and strategy. While a REIT is a more conservative plan than purchasing a property on your own, it has shown to have a more sustainable rate of return over a longer period of time than owning your own property.

Even with the statistics about REIT, many still might want to find the value of it. The value and return on investment of REIT largely depends on multiple economic factors such as interest rates, unemployment, and inflation, among others. While it is difficult to tell what the return of a REIT investment will be in the long-term, it is expected that the current trend of good returns will continue in the coming years.

Commercial real estate can be a great investment opportunity and can work to diversify an investors real estate portfolio. But for some, purchasing commercial real estate may be too complex or too expensive. In those cases, a REIT might be the right way to go. If you are looking to invest in commercial real estate, come see the experts at Harkins Commercial Real Estate.