2025 Guide: Risks of Real Estate Investment Trusts (REITs) and What You Should Know

Real Estate Investment Trusts (REITs) offer investors an accessible way to gain exposure to real estate markets without the need to directly own or manage properties. These investment vehicles generate income by owning and operating diverse real estate assets, distributing at least 90% of taxable income to shareholders as dividends.

Key Insights

• REITs pay out dividends regularly, providing investors with consistent income streams.
• They are traded either publicly on stock exchanges or privately as non-traded REITs.
• Diversification is possible across multiple real estate sectors including residential, healthcare, and retail.

Understanding How REITs Operate

By law, REITs distribute a minimum of 90% of their taxable earnings, which often results in yields surpassing average market returns. In 2023, 74 publicly-listed REITs in the U.S. increased their dividends, reflecting robust performance. Investors can benefit from dividend income without direct property ownership, with holdings that may include:

• Apartment buildings
• Healthcare centers
• Hotels
• Office complexes
• Self-storage units
• Shopping malls and retail hubs

Important Note

REITs are required to pay out the majority of their taxable income, typically exceeding dividends from conventional stocks.

Risks Associated with Non-Traded REITs

Non-traded REITs, which are not listed on public exchanges, pose unique challenges:

• Valuation Difficulties: Lack of public trading means limited transparency and difficulty in assessing true value.
• Liquidity Constraints: Investors may find it hard to sell shares quickly, often facing lock-up periods lasting up to a decade.
• Dividend Sustainability: Dividends may come from new investors’ funds rather than property income, potentially weakening cash flow and share value.
• High Fees: Upfront charges can range from 9% to 10%, with additional management fees reducing overall returns.

Pro Tip

Consider holding REIT investments within tax-advantaged accounts like a Roth IRA to optimize tax benefits.

Risks of Publicly Traded REITs

Public REITs provide liquidity and transparency but still carry risks, including:

• Interest Rate Sensitivity: Rising rates can divert investors to safer government bonds, although higher rates may also signal economic growth boosting rents and occupancy.
• Sector Exposure Risks: Changing consumer habits, such as the decline of malls and rise of e-commerce, affect certain REIT sectors differently. Urban-focused investments might offer better resilience.
• Tax Implications: REIT dividends are taxed as ordinary income, which could be higher than capital gains or qualified dividend taxes, impacting after-tax returns.

By the Numbers

As of 2023, REITs collectively owned more than 575,000 properties across the United States.

Are REITs Risky Investments?

Investing solely in REITs can increase portfolio risk, especially due to sensitivity to interest rates and sector concentration. Diversification and careful evaluation of market trends are essential to mitigate potential losses.

Beware of Fraudulent REITs

Some fraudulent schemes mimic legitimate REITs. Always verify investments by checking registration via the SEC’s EDGAR database to ensure authenticity.

Do All REITs Pay Dividends?

Yes, to qualify as a REIT under IRS and SEC rules, entities must distribute at least 90% of taxable income as dividends, enabling them to avoid most corporate income taxes.

Final Thoughts

REITs offer a convenient, income-generating method to invest in real estate without direct property ownership. However, it’s crucial to analyze dividend yields alongside risks, management quality, property types, and whether the REIT is publicly traded or private. Informed decisions in 2024 can help maximize returns while minimizing potential pitfalls.

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