Are REITs Considered Alternative Investments?

Real Estate Investment Trusts (REITs) allow individuals to invest in large-scale, income-producing properties. Understanding their structure and operations is important for investors. This article explains what REITs are, their place in the investment spectrum, and how individuals can invest in them.

Understanding Real Estate Investment Trusts

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate across diverse property sectors. They allow investors to own shares in real estate without directly managing properties. REITs acquire and develop properties for long-term operation, generating revenue through leasing space and collecting rent.

There are three main types of REITs. Equity REITs own and manage real estate, deriving their income primarily from rents collected from properties such as apartment complexes, shopping centers, warehouses, and office buildings. Mortgage REITs (mREITs) do not own physical property; instead, they provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities. Their earnings come from the interest they collect on these loans. Hybrid REITs combine strategies from both equity and mortgage REITs, holding a mix of property assets and mortgage investments.

For a company to qualify as a REIT under federal tax law, it must meet several requirements. One requirement is the distribution of at least 90% of its taxable income to shareholders annually in the form of dividends. This distribution requirement allows REITs to avoid corporate income tax at the entity level, as the income is taxed directly at the shareholder level. Dividends received from REITs are taxed as ordinary income for shareholders, rather than at the lower qualified dividend rates, although a 20% deduction on qualified REIT dividends may apply through December 31, 2025.

Defining Alternative Investments

Alternative investments encompass assets outside conventional stocks, bonds, and cash. They differ from traditional market-traded securities. They include a wide range of assets such as private equity, hedge funds, commodities, venture capital, and even tangible assets like art or collectibles.

A characteristic of alternative investments is their lower liquidity compared to traditional assets. They are more difficult to sell quickly without significant price impact. Valuation is also more complex due to less frequent trading and less transparent pricing. Many alternative investments have higher minimum investment requirements and fee structures than publicly traded funds.

Alternative investments are sought for diversification benefits within a portfolio. They have a low correlation with traditional investments, meaning performance may not move in tandem with stock and bond markets. This low correlation can help reduce overall portfolio risk and potentially offer protection against inflation.

REITs in the Investment Landscape

REITs share characteristics with both traditional and alternative investments. They offer direct exposure to the real estate market, often considered an alternative asset class. Their income-generating nature, through rents or mortgage interest, aligns with some alternative investment strategies.

Most REITs are publicly traded on major stock exchanges, such as the New York Stock Exchange. This public listing provides liquidity similar to common stocks, allowing investors to buy and sell shares throughout the trading day. This liquidity contrasts with many other real estate investments or private alternative assets, which have limited or no secondary markets. Publicly traded REITs are also subject to regulatory oversight by entities like the U.S. Securities and Exchange Commission (SEC), requiring them to file regular financial disclosures. This transparency and regulatory scrutiny are more akin to traditional public companies than to less regulated alternative investment vehicles.

REITs provide a way to invest in real estate. Their publicly traded structure makes them more accessible and liquid than direct property ownership or private real estate funds. They offer real estate exposure without the operational burdens of property management. Financial professionals consider publicly traded REITs closer to traditional equity investments than to illiquid, complex, privately held assets categorized as alternative investments.

Non-traded and private REITs do exist, which lack the liquidity and transparency of their publicly traded counterparts. These align more closely with the characteristics of alternative investments.

Ways to Invest in REITs

Individuals have several avenues for investing in REITs, primarily through standard investment accounts. The most direct method is purchasing shares of publicly traded REITs on major stock exchanges. This process is similar to buying shares of any other public company and can be executed through a brokerage account.

Another way to invest is through Real Estate Investment Trust Exchange-Traded Funds (REIT ETFs). These funds hold portfolios of multiple REITs, offering diversification across various property sectors and types within a single investment. REIT ETFs are traded on stock exchanges throughout the day, providing liquidity and convenience for investors.

Investors can also consider REIT mutual funds, which are professionally managed funds that invest in a collection of REITs. Unlike ETFs, mutual fund shares are bought or redeemed at their net asset value at the end of the trading day. Both REIT ETFs and mutual funds provide diversified exposure to the real estate sector without selecting individual REIT stocks. These investment vehicles can be accessed through standard brokerage accounts or directly from fund sponsors.