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How does a REIT work?

Here’s everything you need to know about how a REIT works and whether real estate investment trusts are a worthwhile investment to have in your portfolio.

George Sweeney (DipFA)
Latest posts by George Sweeney (DipFA) (see all)
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The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

Nowadays, there are plenty of ways for you to invest your money into a range of assets. One popular way of investing is with property. But is there a way to invest in real estate without having to become a landlord? Say hello to a REIT.

Let’s take a look at everything you need to know about this form of investment to help you decide whether this could be a good option for you.

What is a REIT?

‘REIT’ stands for ‘real estate investment trust’ and is a type of company that focuses on income-generating property.

It’s a good way for investors to make money from real estate without having to become fully-fledged property moguls.

By investing in one of these businesses, you can earn money from property whilst sitting on your sofa. This means no dealing with dodgy tenants, no big mortgage loans and no DIY maintenance jobs.

How do REITs work?

This unique type of investment has an interesting structure. REITs are listed on stock exchanges and money from investors is pooled together to invest in different types of property. So it is an indirect way to invest in real estate.

Most REITs focus on specific types of property, but some contain a mix. This could be commercial buildings or things like private apartment complexes.

There are specific rules that a REIT company must follow in order to remain a real estate investment trust. The rules ensure that investments remain focused on property.

How do REITs make money?

The business model is quite simple to grasp. A REIT generates income using the following steps:

  1. Individuals or companies lease properties in a portfolio
  2. These properties create income in the form of rent, which investors then receive as dividends
  3. This process repeats for all property held in the portfolio, which can lead to a steady stream of recurring income
  4. Properties in the portfolio may also be sold from time to time, leading to an influx of cash

What are the pros and cons?

They have some great advantages for investors:

  • In the UK, REITs are exempt from corporation tax on profits from rental income and the sale of properties
  • 90% of the rental income must be distributed to shareholders
  • Often, a real estate investment trust can be held within a stocks and shares ISA or a SIPP
  • Dividend payments can be a relatively stable source of income for investors

They also have some notable disadvantages:

  • Investments do not tend to grow or appreciate by much
  • Dividend payments are not a sure thing and are reliant on properties making money
  • Paying so much income out to investors means that very little is left for reinvestment
  • They are heavily reliant on the property and housing market
  • Sometimes they have high transaction and management fees

Can you lose money in a REIT?

Although they do tend to provide a stable return for investors, there are no guarantees.

As we saw last year with the coronavirus pandemic, crazy and unexpected things can happen. The property market is quite complex and we’re currently going through a strange period for both commercial and private property.

So it’s important to remember that past performance doesn’t dictate future results and you could lose some or all of your money.

Can you get rich investing in them?

Over a long period, you could build some substantial wealth using something like this if you were to reinvest the dividend payments.

However, you would not have a diversified portfolio if your only focus was property. There’s also the opportunity cost that you’d miss out on gains made by top-performing companies elsewhere in other areas.

So these investments can play a useful part in your portfolio but relying on them too much leaves you at risk.

How do I invest in REITs?

If you think these are for you, investing can be quite straightforward. Most share dealing accounts should give you access to the major players in the UK and abroad.

If you can, holding one of these investments in a tax-efficient account like a stocks and shares ISA can help prevent the dividend payments from affecting your tax position.

Investing like this can be a great way to dip your toes into real estate investment without the usual burdens or barriers. But it’s important to do your research and fully understand the company before investing your money.

Please note that tax treatment depends on the specific circumstances of the individual and may be subject to change in the future.