Are REITs safe investment? REIT risks explained. Mortgage REIT risks.

Are REITs safe investment, especially with not-traded Real Estate Investment Trusts (REITs)?

last updated Thursday, December 26, 2024
#reit risks #Risks of REIT

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John Burson

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What is a real estate investment trust?

Real estate investment trusts or REITs own and operate income-producing real estate or related assets. Assets include office buildings, apartment buildings, hotels, warehouses, mortgages, loans, etc.
The REIT's purpose is to buy or develop properties and operate them as part of its investment portfolio.
REITs allow an investor to earn a share of the income produced through real estate or related assets ownership. The REIT's investors don't need to buy commercial real estate themselves. By owning REIT shares, investors benefit most from owning real estate.

Two main types of REITs.

REITs registered with the SEC and publicly traded on a stock exchange are known as publicly traded REITs. Others that may be registered with the SEC but are not publicly traded are known as Non-Traded or Non-exchange REITs. Before investing in a REIT, you need to understand whether or not it is publicly traded and how it could affect your investment portfolio.

What are the benefits of REITs?

The benefit of REITs is that it offers a way to include real estate in your investment portfolio. Some REITs may offer higher dividend yields than other investments.
However, there are some risks, especially with non-traded REITs:

1. Liquidity of REITs.
   Publicly traded REITs have "regular" liquidity as any publicly traded securities. At the same time, Non-exchange REITs investments can't be sold quickly. If you need to sell for quick money, a non-traded REIT wouldn't be a good choice. You are maybe locked in for months or years.
2. The Value of Share.
   While the market price of publicly traded REITs is accessible and defined by the market as any publicly traded security, non-traded REITs don't give access to determining the value of a share. Non-traded REITs do not estimate their share value until 18 months after their offering closes. This means you aren't going to assess the value and volatility immediately after investing.
3. Although non-traded REITs offer higher dividend yields than publicly-traded REITs, they frequently pay distributions over their funds from operations. To do that, they may use offering proceeds and borrowing. This practice reduces the value of the shares and the cash available to the company for purchasing extra assets.
4. Conflict of interest.
   Non-traded REITs have an external manager instead of their employees, which can lead to potential conflicts of interest with the shareholders.

Mortgage REITs risks

Mortgage Real Estate Investment Trusts (REITs) invest in mortgage-backed securities backed by real estate mortgages. Like any investment, mortgage REITs carry some level of risk. Some of them include the following:

1. Interest rate risk.
   Mortgage REITs are sensitive to changes in interest rates. If interest rates rise, the value of mortgage-backed securities may decline, negatively impacting the value of a mortgage REIT.
2. Credit risk.
   Mortgage REITs are exposed to the risk of default by borrowers on the underlying mortgages. If a significant number of borrowers default on their mortgages, the value of the mortgage-backed securities held by the REIT may decline.
3. Regulatory risk.
   Changes to government regulations and policies, such as changes to the tax treatment of REITs, could impact the performance of mortgage REITs.
4. Prepayment risk.
   If borrowers prepay their mortgages, it can cause the value of the mortgage-backed securities held by the REIT to decline.
5. Liquidity risk.
   Mortgage REITs may have difficulty selling their mortgage-backed securities if there is a lack of buyers. This can create liquidity problems for the REIT.

It's essential to consider any investment risks before deciding to invest. It may be helpful to consult with a financial advisor or professional to determine if mortgage REITs are appropriate for your investment portfolio.

Learn more about REITS investment and risks Risks of investing in Private REIT vs. Public REIT

REIT's fees and Tax considerations.

You can purchase the common stock, preferred stock, or debt security of a publicly traded REIT through a broker. However, brokerage fees will apply for that. A regular broker does not sell non-traded REITs. It has high up-front costs. Sales commissions and upfront fees comprise approximately  9 to 10 percent of the investment.

Most REITs pay 100% of their taxable income to their shareholders. The REIT's shareholders are responsible for paying the tax on the dividends and any capital they gain with their investments. Dividends paid by REITs are treated as ordinary income and are not entitled to reduce tax rates on other corporate dividends. Always consult your tax adviser before investing.

You can verify publicly traded and non-traded REIT registration using SEC's EDGAR system. You can also use it to review a REIT's annual and quarterly reports and offer a prospectus.

Frequently Asked Questions

Are REITs riskier than stocks?

REITs have enjoyed lower volatility compared to stocks. Still, REITs can experience significant price volatility, especially over short periods.

Can you lose money in REIT?

As with any investment, there is always a risk of loss. Run your calculation to help you to define the REIT intrinsic values.

Does Warren Buffett recommend REITs?

Warren Buffett favors real estate investment trusts, companies that own or operate different properties. Warren Buffett doesn't favor investment in physical real estate.

 
 
 

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