9 types of REITs – A guide to risks and rewards of everyday real estate investing
Updated: July 25, 2024
Diversification is a pillar of investing advice. So why do I – and so many everyday investors – still keep our money in plain old stocks, bonds and mutual funds?
Few investment options have democratized real estate like real estate investment trusts (REITs), which give everyday investors access to the kinds of property deals once locked up by well-heeled financiers. By understanding REITs, and your own risk tolerance, you can easily put REITs to work for you – no landlord maintenance required.
What is a REIT?
A real estate investment trust (REIT) company owns, operates or finances income-producing real estate. REITs help individual investors earn a share of the income produced through commercial real estate ownership without actually having to buy or manage properties themselves.
Types of REITs
1 Equity REITs
Equity REITs own income-generating real estate properties, which generate revenue by leasing space and collecting rents on commercial buildings, shopping malls, apartments and office buildings. These REITs focus on buying and managing physical properties, and can also sell properties to realize capital gains.
Who is it for?
These are for investors seeking regular income and long-term capital appreciation from tangible assets.
Benefits: Regular income through dividends, potential property value appreciation.
Risks: Property market fluctuations can impact income and asset values.
Pros
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Steady income stream: Equity REITs provide consistent income through rental payments
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Potential for appreciation: Over time, the value of the properties owned by equity REITs can increase, leading to capital gains
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Diversification: Investing in various properties across different sectors can spread risk
Cons
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Market sensitivity: Property value and rental income can be affected by economic cycles and real estate market conditions
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Management costs: Operating and maintaining properties can be expensive, potentially reducing returns
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Liquidity risks: Selling properties can take time and lead to liquidity issues during downturns
2 Healthcare REITs
Healthcare REITs invest in properties used by healthcare service providers, including hospitals, nursing facilities and assisted living centers. These REITs benefit from the long-term leases typical in healthcare. With an aging population and increasing demand for healthcare services, healthcare REITs offer potential for growth and stability.
Who is it for?
Healthcare REITs are for investors looking for stability and growth potential in healthcare, particularly those interested in demographic trends.
Benefits: Long-term leases provide steady and predictable income.
Risks: Healthcare regulatory changes can impact profitability.
Pros
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Stable income: Healthcare REITs often have long-term leases, providing a predictable and stable income stream
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Growing demand: An aging population increases the demand for healthcare services
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Economic resilience: Healthcare is essential, protecting these REITs from economic downturns
Cons
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Regulatory risks: Regulatory changes can impact the profitability of healthcare facilities
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High initial costs: Investing in healthcare properties can require significant capital investment
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Operational challenges: Managing specialized healthcare facilities can be complex and costly
3 Hybrid REITs
Hybrid REITs combine the strategies of equity REITs and mortgage REITs (mREITs), investing in income-generating properties and mortgages and providing diversified revenue from rents and loan interest. This dual approach allows hybrid REITs to balance steady income from property rentals with higher yields from mortgage interest.
Who is it for?
Hybrid REITs are for investors seeking diversification within real estate, balancing income from rents and interest on mortgages.
Benefits: Offers diversified income sources from both rents and mortgage interest.
Risks: There’s complexity in management and exposure to both real estate and mortgage market risks.
Pros
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Diversified risk: By investing in both properties and mortgages, hybrid REITs spread its risk across different revenue streams
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Multiple income streams: Investors benefit from rental income and mortgage interest, enhancing overall returns
Cons
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Management complexity: Managing both real estate properties and mortgage investments can be complex and resource-intensive
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Potential for lower returns: Balancing two investment strategies might lead to lower returns versus specialized REITs
4 Mortgage REITs (mREITs)
Mortgage REITs invest in and own property mortgages, gaining income from the interest earned on mortgage loans. By investing in either residential or commercial property mortgages, mREITs give investors different real estate exposure compared to equity REITs. Mortgage REITs are highly sensitive to interest rate changes, which can significantly impact its profitability.
Who is it for?
mREITS are for investors looking for high dividend yields and exposure to mortgage markets.
Benefits: High dividend yields from interest income on mortgage loans.
Risks: Interest rate fluctuations can greatly impact profitability.
Pros
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High dividend payouts: mREITs often offer higher dividend yields compared to other REIT types, making them attractive for income-focused investors
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Income in various rate environments: mREITs can perform well in different interest rate environments, depending on its portfolio strategy
Cons
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Interest rate sensitivity: mREITs are highly sensitive to changes in interest rates, which can affect its income and profitability
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Volatility: The value of mortgage assets can be volatile, leading to potential fluctuations in dividend payments
5 Office REITs
Office REITs invest in office buildings and rent space to various businesses. Demand for office space fluctuates with economic conditions, but these REITs benefit from long-term leases with tenants. Increased remote work has introduced new challenges, but prime office locations in major cities still attract stable tenants.
Who is it for?
Office REITs are for investors seeking stable, long-term income from business tenants.
Benefits: Long-term leases with stable business tenants provide predictable income.
Risks: Economic downturns and remote work can affect office space demand.
Pros
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Steady income: Office REITs benefit from long-term leases with corporate tenants, providing reliable income
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Prime locations: Properties in central business districts tend to have high occupancy rates and rental yields
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Professional tenants: Businesses as tenants are generally more stable and less likely to default on leases
Cons
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Economic sensitivity: Demand for office space is closely tied to economic and employment conditions
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High maintenance costs: Office buildings require significant maintenance and capital spending to attract tenants
6 Private REITs
Private REITs are not traded on public exchanges and are typically sold to accredited investors. These REITs offer more flexibility with investment strategies and properties but carry higher risks and less liquidity. Private REITs are often used to target niche markets or unique investment opportunities that may not be available through public REITs.
Who is it for?
Private REITs are reserved for accredited investors seeking higher returns and willing to accept higher risks.
Benefits: Potential for higher returns and greater investment flexibility.
Risks: Lack of liquidity and transparency compared to publicly traded REITs.
Pros
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Higher return potential: Private REITs can offer higher returns due to its ability to invest in niche markets and unique opportunities
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Investment flexibility: These REITs can pursue diverse strategies, including development projects and specialized property types
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Less regulatory oversight: Private REITs can operate with fewer regulatory constraints, allowing for innovative investment approaches
Cons
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Limited liquidity: Investors in private REITs may find it difficult to sell their shares, especially during market downturns
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Higher risk: The potential for higher returns comes with higher risks, including market, operational and management risks
7 Public Non-Listed REITs (PNLRs)
Public non-listed REITs (PNLRs) are trusts registered with the Securities and Exchange Commission (SEC), but don’t trade on major stock exchanges. They pool funds to invest in a diversified portfolio of real estate properties, similar to publicly traded REITs. PNLRs typically focus on long-term investments and may have lock-up periods, meaning investors must hold their shares for a certain period before selling.
Who is it for?
PNLRs are for investors willing to accept limited liquidity for potentially higher long-term gains.
Benefits: PNLRs offer higher return potential compared to publicly traded REITs and provide some liquidity and regulatory oversight.
Risks: Limited liquidity, potential high fees and the lock-up period.
Pros
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Higher return potential: PNLRs often target higher returns by investing in long-term real estate projects
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Regulatory oversight: Being registered with the SEC ensures a level of transparency and investor protection
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Lower volatility: Reduced sensitivity to daily market fluctuations provides a more stable investment
Cons
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Limited liquidity: Shares aren’t as easily traded as publicly listed REITs
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High fees: PNLRs can have higher management and performance fees
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Lock-up periods: Investors may be required to hold their shares for extended periods
8 Retail REITs
Retail REITs invest in properties like shopping centers, malls and retail parks. They generate income by leasing space to retailers, including department stores, specialty shops and restaurants. The success of these REITs is closely tied to the performance of the retail sector and consumer spending. Retail REITs often focus on prime locations with high foot traffic to attract a diverse range of tenants. This diversification aims to maintain high occupancy rates and drive steady rental income.
Who is it for?
Retail REITs are suitable for investors looking for regular returns from well-located retail properties.
Benefits: Retail REITs offer regular income through long-term leases with tenants and potential capital appreciation from high-demand retail properties.
Risks: The chief risk is exposure to the volatile retail market and the impact of e-commerce on brick-and-mortar spaces.
Pros
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Steady income: Long-term lease agreements with retail tenants can provide steady income
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Prime locations: Properties in high-traffic areas tend to have higher occupancy rates and yields
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Diverse tenant mix: Leasing to various retailers can reduce the risk of relying on a single tenant or sector
Cons
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Market volatility: Retail REITs are highly sensitive to economic conditions and consumer spending trends
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E-commerce impact: The growth of online shopping can reduce demand for physical retail spaces
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High maintenance costs: Maintaining attractive retail properties requires significant capital expenditure
9 Residential REITs
Residential REITs own and operate residential properties such as apartment complexes, multi-family housing units and single-family rental homes. These REITs generate income from rental payments and can benefit from increasing housing demand, especially in urban areas with growing populations.
Who is it for?
Residential REITs are suitable for investors seeking stable income over the long haul without the hassle of direct property management.
Benefits: Residential REITs offer steady rental income and potential property value appreciation and professional property managers handle the dirty work.
Risks: Market fluctuations can affect rental demand.
Pros
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Stable income: Residential properties typically provide consistent rental income, especially in high-demand areas
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Capital appreciation: Over time, property values can increase and raise gains
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Professional management: Investors gain from professional property managers who handle tenant relations and maintenance
Cons
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Market sensitivity: Rental income can be affected by economic cycles, employment rates, and changes in housing demand
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Regulatory risks: Changes in housing laws and rent control regulations can impact values and income
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Operational costs: Managing residential properties involves significant maintenance and operational expenses
Are REITs a good investment?
REITs are a solid way to diversify with real estate exposure without directly owning properties. They offer regular income through dividends and potential for capital appreciation. However, investors should consider their risk tolerance, as REITs can be affected by market fluctuations and economic conditions.
FAQs
Chris Clark is freelance contributor with MoneyWise, based in Kansas City, Mo. He has written for numerous publications and spent 18 years as a reporter and editor with The Associated Press.
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