A Complete Guide to Equity REIT Investing

Equity REITs allow investors to benefit from a diversified portfolio of income-producing commercial real estate. How do equity REITs work, and how can you invest in them?

Equity REITs Defined

Equity real estate investment trusts, also known as equity REITs, are indirect investment vehicles that own or operate income-producing commercial real estate, such as office buildings, shopping centers, apartments, and many other property types. Equity REITs differ from mortgage REITs, which primarily invest in bonds backed by home mortgages. You can learn more about mortgage REITs in this guide.

Equity REITs are indirect investment vehicles because there is a professional money management team that selects the direct real estate investment properties on behalf of REIT shareholders. 

Public equity REITs are registered with security regulators, such as the U.S. Securities Exchange Commission (“SEC”). Most public equity REITs trade in the secondary market on a stock exchange. These public REITs are liquid in that they can be sold during the market trading day with the proceeds from the sale received within a couple of days once the trade settles.

Some public equity REITs are registered with the SEC or other security regulators but are not listed on a stock exchange.

Private REITs are not registered with security regulators. Most private REITs are bought directly from the REIT sponsor and are less liquid than public REITs because the shares have to be repurchased by the fund sponsor.

Some private REITs set a limit to the percentage of outstanding shares they are willing to purchase each year. This repurchase limit can be as low as 5% of the outstanding shares.

Equity REIT Sectors

Equity REITs own and manage a wide variety of property types as shown in the following graphic and table: 

How REITs Are Taxed

Real estate investment trusts receive special tax treatment if they meet certain conditions set out by taxing authorities. These conditions vary by country. The main criteria to be classified as a REIT in the U.S. are:

1. The REIT must be owned by more than 100 shareholders. 
2. The REIT must have more than 75% of its assets invested in real estate, government securities, or cash. 
3. 75% or more of the REIT’s gross income must be derived from real estate activities. 
4. At least 90% of the REIT’s taxable income must be distributed to shareholders as dividends.

If a U.S. REIT meets the requirements, it can deduct its dividend payments from its taxable income, which means REITs pay little if any income tax.

Most corporations do not receive a tax deduction for dividends paid to shareholders, so these corporations pay dividends from after-tax income. REITs can pay higher dividend amounts than regular corporations because REITs pay dividends from pre-tax income.

How REITs Work

REIT operators distribute most of their taxable income to shareholders through dividends. These operators generate the majority of that income from the properties they own. They seek to grow their income and dividends by increasing the rent on their existing properties and by acquiring new properties.

REIT operators raise funds to purchase new income-producing properties by borrowing money and by issuing new stock shares.

Real estate investment trust operators also seek to improve profitability by selling existing properties and reinvesting the proceeds in properties that can generate a higher return. 

Equity REIT Returns and Risk

As equity REITs expand their real estate portfolios’ size and profitability, that leads to higher returns for REIT investors. The three factors that determine the total return for equity REIT investing are:

1. The dividend yield
2. The growth in the dividend over time
3. Changes to what investors are willing to pay for REITs now versus later

Dividend yields have historically comprised about 40% to 60% of REIT returns. The dividend yield for U.S. equity REITs has averaged 3.9% over the past decade. U.S. equity REITs comprise about 65% of the global equity REIT market.

For the ten years ending February, 20223, global equity REITs returned 5.0% annualized, as measured by the S&P Global REIT Index. U.S. equity REITs, as measured by the Dow Jones U.S Equity All REIT Index, have returned 7.0% annualized for the decade ending February 28, 2023.

A reasonable return assumption for equity REITs over the next decade can be derived using the existing REIT dividend yield and adding a dividend growth rate assumption.

For example, with U.S. equity REIT dividend yields at 3%, if dividends grow at 3% to 4% per year, then a reasonable expected return for equity REITs is 6% to 7% annualized. This assumes investors are willing to pay the same amount in the future for each dollar of REIT earnings or dividends as they do today. 

If REIT investors are willing to pay a higher multiple for earnings or dividends in the future than they do today, then investors could earn more than 6% to 7% annualized over the next decade.

If REIT investors are willing to pay less, then REIT returns will fall short of 6% to 7%. REITs will also fall short if REIT earnings grow slower than 2% per year. 

Equity REIT Risk

Equity REITs have a similar risk profile as stocks. In fact, some stock indices include REITs and other real estate companies as part of their index.

Investing risk is often measured by volatility, which considers to what extent do returns deviate from the expected average outcome. In other words, how high are the highs and how low are the lows relative to the average return.

As investors, we should be more concerned with downside volatility—losing money. Equity REITs suffered a loss of 60% during the 2008-2009 financial crisis. It took almost four years to recoup those losses.

Equity REIT investors should be prepared for losses of that magnitude and duration.

Equity REIT Valuations

There are several valuation metrics investors can use to determine if REITs are more expensive or cheaper than they have been historically. Analyzing these metrics helps investors evaluate if REIT returns might be lower in the future because REITs are richly valued today.

Several of these valuation metrics are explained below.

Dividend Yield

The most straightforward metric is the dividend yield relative to both the average REIT dividend yield and yields on government bonds. NAREIT provides current and historical U.S. REIT dividend data for free.

Price-to-Funds-from-Operations

Another metric for evaluating equity REITs is price to funds from operations. Funds from operations (“FFO”) measures a REIT’s net cash flow from operations. 

FFO is calculated by taking the equity REIT earnings and adding non-cash expenses like depreciation and amortization and then subtracting gains on the sale of properties.

Investors can compare the current price-to-FFO for a REIT or REIT index to the historical price-to-FFO. Unfortunately, FFO calculations for equity REITs and indices are not always readily available for free.

Price to Net Asset Value

A final metric for analyzing REIT valuations is the price to net asset value. A REIT’s net asset value (“NAV”) reflects the per-share market value of the REIT’s assets minus its liabilities.

The NAV per share can then be compared to the equity REIT’s share price to see it is selling at a premium or discount relative to the net asset value.

When equity REITs sell for a discount to the net asset value, it suggests REITs are either undervalued or that REIT investors anticipate the market values for commercial real estate will fall, reducing the discount. 

When equity REITs sell at a premium to the net asset value, it suggests REITs are either overvalued or that REIT investors anticipate the market values for commercial real estate will increase, eliminating the premium.

How To Invest in Equity REITs

While investors can research and invest in individual public REITs, most investors will find it easier to invest in an equity REIT mutual fund or exchange-traded fund. 

REIT ETFs

An equity REIT exchange-traded fund is a low-cost way to invest in a diversified public REIT portfolio. An equity REIT ETF seeks to track a specific REIT index. There are equity REIT ETFs that track REITs in a specific country and ETFs that track equity REITs globally.

Example Equity REIT ETFs

Here are some examples of equity REIT ETFs.
Note: The links below are affiliate links; if you click and make a purchase we may earn a commission at no additional cost to you.

REIT Mutual Funds

Another option for equity REIT investing is an active REIT mutual fund. Rather than seeking to track a specific REIT benchmark, active REIT managers select individual REITS that they believe will outperform the index. Active REIT investors can overweight and underweight REIT sectors. 

While some active REIT mutual funds have outperformed equity REIT indices and ETFs, most have not. According to Morningstar, 45% of active U.S. equity REIT and real estate mutual funds have outperformed comparable REIT and real estate index funds and ETFs for the 10-years ending June 30, 2021. Only 27% of active U.S. equity REIT and real estate mutual funds outperformed comparable passive vehicles over a 15-year time period.

Private REITs

Investors can also invest in a private REITs such as the eReits offered through the FundRise platform. You can learn more about Fundrise in our review of the FundRise Interval Fund.

Private REITS will usually have a more concentrated portfolio than a public REIT ETF or mutual fund. In addition, private REITs will often charge a redemption fee if the holding is sold within the first few years of ownership. Private REITs are also less liquid as the REIT sponsor will only buy back a certain amount of outstanding shares each quarter.

Benefits of REIT Investing

Equity REIT investments allow investors to gain exposure to a diversified portfolio of income-producing commercial real estate while relying on professional managers to select and manage the properties.

Equity REIT investments provide investors with an attractive dividend yield that is higher than the overall stock market. 

Public equity REIT ETFs and mutual funds are liquid and can have low expense ratios, providing investors with a convenient and flexible way to invest in real estate.

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