REIT investing is a great way to invest in real estate without actually owning the properties. REITs invest in properties, collect rent, and then pass the profit on to shareholders. REITs have special tax treatment and can be profitable for both investors and taxpayers. They may also receive special tax breaks, such as a 20% pass-through deduction on dividends.
REITs raise money from shareholders to expand their business. How much a REIT pays for this money is a key factor in determining its long-term investment potential. There are three major sources of capital for REITs, namely undistributed cash flow (DCF), equity, and debt. Total interest expense (TI) is the cost of debt capital for a REIT.
Historically, REITs have outperformed the S&P 500 when Treasury yields rose. This positive relationship between rising rates and rising REIT returns indicates that fundamentals of real estate are improving. But REITs have experienced inflation during the current economic recovery, with annual inflation measured by the Consumer Price Index reaching 8.5% in March 2022. The investment risk associated with mortgage REITs is higher than that of equity REITs. Consequently, increased interest rates could depress book value of mortgage REITs, driving down the stock price.
Despite the risks associated with real estate investing, REITs provide a steady stream of dividends. These earnings are taxed like regular income and REITs must return 90% of taxable income to their shareholders. However, the downside to investing in REITs is that they are unlikely to produce much capital appreciation over the long term. However, REITs are a great option for real estate investors who want to avoid the hassle of buying and selling physical properties.
