What are Residential REITs?

A residential real estate investment trust (REIT) is a company that owns and operates income-generating residential properties. REITs earn revenue by renting out these spaces to tenants who pay rent.

REITs can be a way to invest in real estate without having to cover the upfront costs and mortgage payments that come with buying property. Investing in a REIT can also be a way to earn income from real estate without having to manage or maintain the property yourself. Not all real estate investment trusts (REITs) are companies that specialize in residential properties.

Residential REITs vs. other REITs

REITs give investors with less cash or savings the opportunity to buy and earn money from properties that they wouldn’t be able to afford on their own. REITs also give investors the chance to buy into real estate without having to take out a large mortgage loan.

REITs are like residential mutual funds in that both are real estate investment opportunities that can either be actively or passively managed. However, REITs are focused on direct property ownership, while mutual funds are a larger pool of investments that can include different REITs. They’re also taxed differently.  REITs are taxed as income and mutual funds are taxed as long-term capital gain rates.

A residential REIT differs from a commercial REIT because it’s only used to purchase residential properties. The properties that a residential REIT might purchase include single-family homes, student housing, apartment buildings, manufactured housing, condos, and townhomes.

Commercial REITs can be classified into 12 different types:

• Office
• Retail
• Hotel
• Industrial
• Healthcare
• Data centers
• Mortgage
• Self-storage
• Infrastructure
• Timber
• Diversified
• Specialty

Compared to commercial REITs, residential REITs can be less vulnerable to market fluctuations and economic downturns. After all, people still need a place to live even when the economy is in a slump. The downside is you can expect a higher turnover rate with tenants in an apartment building than you would in a commercial office space. Overall, residential REITs provide stable, lower-risk revenue, while commercial REITs have the potential for higher returns.

Be sure to do careful research and consult a professional before choosing a REIT to invest in.

How do you make money from residential REITs?

If you think you might be interested in investing in a residential REIT, then it’s important to understand how they can generate passive income. Investors generally make money on REITs through dividend payments and stock exchange trades.

Dividend payments

Residential REITs make dividend payments to investors on a regular basis. Federal law requires REITs to distribute at least 90% of their earnings as dividends to shareholders. The size and timing of these payments will depend on the performance of the REIT and the payment schedule set by the REIT. Most REITs pay dividends quarterly, though some pay monthly or semi-annually.

A dividend yield is a figure that reflects how much income your investment produces and is measured as a percentage of the current stock price. It’s measured by taking the dividend amount and dividing it by the stock price. If the REIT pays you $12 in annual dividends and the current stock price is $200, the dividend yield is 6%. The average REIT dividend yield can vary but typically ranges from 3% to 8%.

Investors also make money by holding onto their REITs and selling them after they’ve increased in value. As with any investment, there’s no guarantee that a specific REIT will increase in value, as with any investment.

New York Stock Exchange trades

Public residential REITs are traded like stocks on the New York Stock Exchange and are fairly simple to invest in. That means you can purchase shares through a brokerage account just like you can with stocks. If its value increases between the time you buy and sell shares, this is another way you can earn money from a REIT.

You should consult a financial advisor before undertaking any investment.

What is a residential REIT ETF?

Exchange-traded funds (ETFs) are securities made up of different stocks and bonds that can be purchased or sold on a stock exchange, much like any other type of stock.

A residential REIT ETF is a REIT that focuses exclusively on residential properties. REIT ETFs are attractive because they include several individual REITs within them. They’re a bit like mutual funds. If you invest your dollars in a REIT ETF, you’re buying into several REITs and not just one residential REIT.

Pros and cons of investing in residential REITs

As with any investment, there are both positives and negatives associated with investing in residential REITs.

Pro

Let’s start by exploring some potential benefits of investing in residential REITs.

• Diversification: Diversifying your portfolio protects you against the normal ups and downs of the economy. If other investments are in a slump, the housing market might be performing well.
• Recession resistance: Residential REITs are one of the more recession-resistant investment vehicles. People still need homes to live in even if the economy is in a recession or unemployment is rising.
• Dividend payments: REITs are required by federal law to pay out 90% of their taxable income to shareholders. Because of this, their dividend payouts are often higher than what investors receive when they invest their dollars in stocks.
• Liquidity. Because REITs are listed on a national stock exchange, they are considered liquid assets. Like stocks, they can be more easily converted into cash compared to other types of real estate investments.
• Low up-front costs. Buying a property yourself requires high up-front costs to cover a down payment and closing costs. Then you’ll need enough income to keep up with the mortgage payments. With a REIT, all you need is enough to cover individual shares.

Cons

As a real estate investor, you might also experience certain drawbacks of buying and managing REITs. Let’s take a look at some of the cons.

• Tax drawbacks: REIT dividend payments are rarely considered qualified dividends by the IRS. This means that these dividends are taxed as income instead of long-term capital gains. Speak with a tax advisor to make sure you understand your individual liability.
• Real estate market fluctuations: Like other real estate investments, REITs are sensitive to changes in the market. If property values drop or there’s low demand in that market, this can affect revenue, dividends, and share value.
• Interest rate sensitivity: The performance of REITs often suffers when interest rates rise. For instance, if the Federal Reserve raises interest rates, the value of REITs could drop.
• Rising property taxes: States have the power to increase property taxes, a tool they often turn to when they need more revenue for their budgets. When property taxes rise on the properties that a residential REIT has invested in, the earnings on these REITs will fall.

When is the right time to invest in residential REITs?

If you’re considering investing in residential REITs, timing can make all the difference. Here are a few indicators that it could be a good time to invest in residential REITs.

The housing market is doing well

The best time to invest in residential REIT stocks is when the housing market is in strong shape. Check housing prices and apartment rents in your area. Are they increasing? Then residential REITs will generally perform well.

When the residential REIT market is undervalued

When the residential REIT market is undervalued, that means that residential REITs are trading on stock exchanges for less than they’re actually worth.

When there’s population or job growth

Population and job growth stimulate demand for both residential and commercial REITs. Some REITs work to keep their portfolios diversified to focus on high-growth local markets.

There’s low inventory of homes for sale

You can also look at the demand for housing in cities across the country. When the inventory of available homes is low or when vacancies in apartment buildings are falling, this is a good market in which to invest in a residential REIT.

Mortgage interest rates are low

If mortgage interest rates are low, residential REIT stocks will enjoy a stronger performance. If they’re high or rising, the financial performance of a residential REIT might take a hit.

Keep in mind that investing in residential REITs isn’t a short-term financial move. You’ll generally have to hold onto your REIT investment for several years for it to rise in value enough to generate a solid profit.

You’re using a long-term investment strategy 

REITs offer the highest returns by paying a high dividend yield over the long term. Plus, they also offer the potential for capital appreciation over the years. You can maximize your investment in a REIT if you plan to hold on to your shares for a while.

How to invest in residential REITs

Once you decide it’s the right time to invest, you’ll need to know how to start the process. Here are the steps to take.

1. Do your research

Every investment requires research, whether you’re sinking your dollars into stocks, mutual funds, mortgage bonds, or a residential REIT. Before investing in a REIT, research the company behind it. You’ll also want to research the current state of the real estate market and where mortgage interest rates might be headed for the year.

2. Open a brokerage account

To start investing in REITs, you’ll first open a brokerage account. You’ll transfer money into and out of this account, much like you would with a savings or checking account. Brokerage accounts, though, give you access to the stock market and other investments, including REITs.

3. Buy into an individual REIT or invest in a REIT ETF

According to the National Association of Real Estate Investment Trusts, a trade association representing REITs, about 145 million U.S. residents are invested in REITs through their retirement savings and other financial funds. These investors purchased REITs through a REIT ETF, a fund that includes several different REITs inside it.

When you’re investing in REITs, you can invest your dollars directly with an individual REIT or spread them out among many REITs through a REIT ETF.

4. Work with a professional

You might consider working with a financial planner or investment advisor when selecting REITs. These financial professionals can help you determine which REITs make the most sense for you.

The bottom line: Residential REITs can diversify your real estate portfolio

REITs give you the opportunity to invest in real estate without spending the big upfront and ongoing costs required to purchase rental properties or commercial spaces. They also let you avoid the work of managing properties or acting as a landlord.

If you’re interested in real estate, a residential REIT can make buying into apartment buildings, single-family homes, and manufactured homes a fairly simple process.

Not sure that residential REITs are the right investment for you? Learn about the other types of real estate investments and see which could be the best fit for you.