The short version
- Commercial REITs are a type of real estate investment fund that allow investors to invest in commercial real estate that may otherwise have been too expensive.
- There are several pros (such as steady dividends) and cons (such as you may not make money from the appreciation) to this type of investment.
- If you want to invest in commercial real estate, but don't want to buy a property directly, a commercial REIT may provide faster diversification with lower capital requirements.
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How REITs work
REITs might hold office, retail, industrial, and multi-family (residential complexes such as apartment buildings) properties. Investors purchase and hold commercial investment properties for two primary purposes: to earn a return through rental income and to make money from property appreciation over the time the asset is held.
Congress created REITs in 1960. These special investment vehicles made commercial real estate more accessible to everyday investors. Before that, investing in commercial real estate was limited to institutions and wealthy individuals because so much capital was needed to own and manage these properties.
As a particular class of regulated securities, REITs must meet certain IRS standards that help mitigate investor risk. Below are some of the requirements:
- Return a minimum of 90% of taxable income in the form of shareholder dividends each year
- Receive at least 75% of gross income from real estate activities within the REIT, such as rent collection and interest payments on mortgages financing the properties held in the REIT
- Invest at least 75% of total assets in real estate
- Have a minimum of 100 shareholders after the first year of inception
- Have no more than 50% of the shares owned by five or fewer individuals during the last half of the taxable year
How to invest in commercial REITs
Commercial REITs fall into main categories: traded and non-traded. Here's a quick look at how to invest in both types:
Traded commercial REITs
Purchasing shares in publicly-traded REITs is as straightforward as buying shares of a mutual fund. All you need is a brokerage account and enough money to purchase at least one share. As such, they are very accessible to any investor, are very liquid and require a relatively low minimum investment.
Non-traded commercial REITS
Non-traded REITs are also attractive investments that are often more specialized by the asset's location and type and require a higher minimum investment. Here are a few of the larger commercial REITs:
- Orion Office REIT (ONL) owns and manages a diversified portfolio of office buildings and company headquarters. There are leased primarily on a single-tenant net lease basis and are located in suburban markets across the U.S.
- Public Storage (PSA) owns and operates more than 2,700 self-storage facilities in 39 states, with more than 190 million net rentable square feet of storage space. Through equity interests, it also has exposure to the European self-storage market and an additional 29 million net rentable square feet of commercial space in the U.S. through PS Business Parks.
- Equity Residential Properties (EQR) is the largest apartment REIT in the U.S. At the end of 2021, EQR owned or had investments in 310 properties with about 80,407 apartment units.
Several real estate crowdfunding platforms now offer non-traded commercial REITs as well. Here are a few examples:
- Fundrise now has a dozen REITs, each of which include a significant portion of commercial real estate. The minimum investment with Fundrise is $10 and the annual management fee is 1%.
- Realty Mogul has two REITS, both of which exclusively invest in commercial properties. The minimum investment for Realty Mogul's REITS is $5,000 and fees range from 1% – 1.25%.
- In 2022, CrowdStreet announced the launch of its own commercial REIT, called C-REIT. The minimum investment for C-REIT is $25,000 and it appears that investors will be subject to a 1.50% management fee as well as a 0.50% servicing fee.
Pros & cons of commercial REITs
- Passive income: REITs offer a convenient way to invest in commercial real estate in a truly passive way. You don’t need to buy or manage any properties yourself.
- Steady dividends: The IRS requirement that REITs distribute 90% of their earnings means that steady, reliable dividends are the investor’s reward. Many REITs have a track record of paying large and growing dividends year after year.
- Liquidity: Real estate as an asset class is mainly illiquid, but REITs operate much like mutual funds offering convenient and quick liquidity if you need to get out.
- Less volatility: REITs can act as a buffer against the ups and downs of other asset classes such as stocks.
- Lower minimum investment: To buy a commercial property, you might need hundreds of thousands of dollars to purchase and manage the asset. The typical minimum investment in a public, commercial REIT is a reasonable $250.
- Real estate diversification: Low minimum investments make it affordable to diversify because you can buy shares of many REITs invested in different commercial assets rather than just one REIT.
- Limited/no property appreciation benefits passed onto investors: While regular dividend payouts are all but guaranteed, REIT investors may not benefit from capital appreciation of the assets held.
- Minimum investment can be high: Some non-traded REITs demand $25,000 or more to participate.
- Debt risk: REITs, by owning large properties, typically carry large amounts of debt. Debt can be risky, especially if interest rates increase. However, with well-managed commercial REITs, this risk is largely mitigated by the long-term leases that produce predictable and steady rental income for the REIT.
The bottom line
Commercial real estate properties require a large amount of capital to purchase and maintain. This used to limit the asset class to high-net-worth individuals and large institutional investors. But REITS provide a way for smaller individual investors to add real estate holdings to their overall investment portfolio without purchasing, maintaining or managing real property.
REITs must adhere to specific IRS regulations and business practices that protect investors from being taken advantage of. Like many investing options that are traded on the major exchanges, commercial REITs offer the benefits of liquidity, dividends, diversification and low minimum investment. To determine if commercial REIT investing is right for you consider your overall investment strategy and your specific portfolio of investments.
- How to invest in real estate with little money
- Is real estate a good investment right now?
- What are the risks of investing in real estate?
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