Everything You Need To Know About Different Types of REITs

Real Estate Investment Trusts, or REITs, have emerged as a valuable tool for investors looking to diversify their portfolios and gain exposure to the real estate market without the burdens of property ownership. At their core, REITs are companies that own, operate, or finance income-generating real estate. These entities provide individuals with the opportunity to earn returns from property investments in a liquid and regulated manner

What makes REITs an essential part of many portfolios is their accessibility, high dividend yields, and ability to offer stable income streams. Today, we will explore the various types of REITs, their advantages and disadvantages, and how investors can make decisions that align with their goals. Let’s take a deep dive into everything you need to know about different types of REITs before investing.

Understanding Equity REITs

Equity REITs are the most common and perhaps the most straightforward type of REIT available. They focus on acquiring, managing, and owning properties that generate rental income. These could include office buildings, retail centers, apartments, hotels, warehouses, and even healthcare facilities. Investors benefit from the rental income these properties produce and from potential appreciation in property value over time.

Equity REITs typically specialize in specific property sectors. For example, a healthcare REIT might primarily invest in hospitals and senior living facilities, while a retail REIT could focus on shopping malls and strip centers.

A Closer Look at UPREITs

An Umbrella Partnership Real Estate Investment Trust (UPREIT) is a unique structure that allows property owners to defer capital gains taxes when contributing their real estate holdings. Instead of selling a property outright, owners transfer it to the UPREIT in exchange for Operating Partnership (OP) units. These OP units are akin to shares and typically offer the holder liquidity options, such as converting them into REIT shares at a later date.

This investment method may sound complex at first but will become relatively straightforward if you’re working with a specialist. For example, at Sera Capital, our 721 exchange advisors specialize in UPREITs, making them more accessible to interested investors.

This structure is particularly advantageous for property owners looking to diversify their investments while avoiding immediate tax liabilities. For investors, UPREITs can provide access to high-value properties that might otherwise remain inaccessible through traditional REITs. However, it’s essential to evaluate the terms of the operating agreement and consult with financial and tax advisors to ensure alignment with financial and tax planning goals.

An Introduction to Mortgage REITs

Mortgage REITs, commonly referred to as mREITs, offer an alternative to equity REITs or UPREITs. Instead of owning physical properties, mREITs invest in mortgages and mortgage-backed securities. These REITs generate income by earning a spread between the interest they receive on mortgage loans and the cost of funding these loans. Essentially, mREITs are lenders that thrive on shifts in financial markets and credit cycles.

For those seeking exposure to the real estate sector without owning physical property, mREITs can be an appealing option. However, they may be better suited for experienced investors or those with a higher tolerance for market volatility.

The Unique Appeal of Hybrid REITs

Hybrid REIT structures feature a mix of equity REITs and mortgage REITs. These entities invest in both properties and mortgage-related assets, providing investors with the best (and sometimes worst) of both worlds. Investors in hybrid REITs gain exposure to rental income, property appreciation, and the interest income generated from mortgage investments.

While hybrid REITs are less common than their equity and mortgage counterparts, they can serve niche purposes for investors seeking a diversified real estate play.

Weighing the Pros and Cons of Each Type

Discussing everything you must know about different types of REITs requires weighing the pros and cons of each option available.

Equity REITs offer stability and income, driven by tangible properties and consistent rental yields. Their performance correlates closely with real estate market trends and economic activity. However, their reliance on property management and market demand can make them sensitive to changes in occupancy rates and market saturation.

On the other hand, UPREITs offer significant tax advantages they enable property owners to defer capital gains taxes on the transfer of their assets. For investors, UPREITs provide additional flexibility and potential liquidity while still maintaining exposure to the real estate market.

Mortgage REITs, on the other hand, provide high yields, appealing to income-focused investors. The flip side of the coin is their vulnerability to interest rate fluctuations and credit risks, which can lead to significant volatility in returns.

Hybrid REITs provide a balanced approach, blending the income-generating potential of equity REITs with the financial play of mREITs. However, this combination can also create a level of complexity and uncertainty for investors, as hybrid REITs are influenced by factors that impact both property-based and mortgage-based investments.

The Essentials of Investing in REITs

Investing in REITs starts with defining clear investment goals. Are you seeking steady income, long-term growth, or a combination of both? Understanding your objectives will help narrow down the REIT types that align with your financial plans.

Conducting thorough evaluations is the next crucial step. Look into a REIT’s management team, property portfolio, historical performance, and dividend payout history. Financial metrics such as Funds From Operations (FFO) provide deeper insights into a REIT’s profitability.

Investors must also comprehend the tax implications of REITs. While REITs offer attractive dividend incomes, these distributions are typically taxed as ordinary income, which might affect your net returns. Consulting with a financial advisor can provide clarity on how REIT investments align with your taxable income and broader portfolio.

Maximizing the Potential of REIT Investments

A REIT is not just one type of investment option—it comes in many variations. For example, you can find publicly traded REITs on major stock exchanges, while non-traded REITs are not available this way. Trading methods will vary in liquidity and other key factors, so choose your option wisely. At their core, REITs offer an accessible and rewarding way to invest in the real estate sector.

By understanding the differences between equity REITs, UPREITs, mREITs, and hybrid REITs, investors can make smart decisions that align with their financial goals and risk tolerance. Successful REIT investing relies on thorough research, an awareness of market conditions, and a clear strategy tailored to individual needs.

Whether you're a novice or seasoned investor, REITs present an opportunity to diversify and earn consistent income. Take the time to explore the rich variety of REIT options available, and remember—knowledge is the key to unlocking the full potential of your investments.

Start investigating REITs today, and you may just find a new avenue for financial growth. Don’t hesitate to schedule your free consultation with Sera Capital if you want to talk to an independent, transparent fee-only fiduciary as soon as possible.