Once you learn about the massive cash flow you can earn investing in real estate, you’ll become as obsessed with the idea of owning properties as little girls were with Justin Timberlake in the 90s. By owning just one multifamily, you can get other people to pay your mortgage and start living rent-free. If eliminating one of your biggest expenses sounds great, just wait until you get a few more properties under your belt. You’ll be living rent-free and have thousands of extra dollars flowing in every month. Sounds like living the dream!
But what this fairytale scenario leaves out is how hard it can be to get property number one. You have to save for a 3.5% down payment, which can be sky-high depending on where you live, and astronomical student loan debt can send your debt to income ratio through the roof and leave you with no loan options.
If you’re stuck in this situation or the thought of dealing with tenants makes you want to pull a Gone Girl move, no worries. There’s a cheap and easy way you can become a real estate investor today without having to buy your own property. Allow me to introduce you to a REIT.
What is a REIT?
REIT is an acronym that stands for Real Estate Investment Trust. There are two types of REITs, Equity REITs, and Mortgage REITs, and they make money in completely different ways.
Equity REITs are the most common and make money the same way you would with your own investment properties. They build, renovate, and operate properties that they lease out to tenants. You can think of them as the Jonathan Scott of the Property Brothers. They’re not afraid to get their hands dirty.
Some equity REITs specialize in a specific market segment and only hold residential real estate, office buildings, or buildings in the healthcare industry. Each of these industries has its pros and cons, but as a whole, equity REITs generate the majority of their revenue from collecting rents.
Mortgage REITs don’t make money operating investment properties but rather by lending money to the people who do operate them. They’re the Drew Scott of the Property Brothers. They handle the business side.
Mortgage REITs make money from the interest they charge on the money they lend to real estate investors and from mortgage-backed securities. These are bundles of mortgages sold together as a single investment so companies can make money off of the mortgage interest.
How to Invest in a REIT
REITs are as easy to buy as stocks and are a great option for anyone who wants to become a real estate investor or add more income-generating assets to their portfolio. Both mortgage and equity REITs are required to pay 90% of their income to shareholders in the form of dividends, and if you own an equity REIT, you can also benefit from the property appreciation on the REIT’s holdings. This makes REITs a great income and growth option to add to your portfolio.
Adding a REIT to Your Portfolio
The simplest way to add a REIT into your investment mix is to create a 4 fund portfolio. This portfolio structure includes the following funds
- Domestic Stock Fund
- International Stock Fund
- Domestic Bond Fund
To determine the asset allocation of your portfolio, start by deciding how much of it you want to allocate to bonds. Aggressive portfolios typically allocate 10-20%, and conservative portfolios allocate more. Once you know your bond fund allocation, then you can invest in the remaining funds at the following percentages
- Domestic Stocks – 60%
- International Stocks – 30%
- REITs – 10%
To buy your investments, you’ll need to convert these percentages into the amount of your entire portfolio they’ll make up. For example, let’s say you decide to allocate 10% to bonds. First, take 100% minus your bond allocation of 10% to get the percentage of your portfolio that your other three funds will make up. In this example, 90%. Next, you’ll need to figure out how much of your portfolio the domestic stock fund will make up. To do that, multiply your portfolio balance of 90% by the 60% recommended allocation for this fund to get 54%. Then repeat this for the two remaining funds. The entire portfolio allocation for this example would be as follows
- Bonds – 10%
- Domestic Stocks – 54%
- International Stocks – 27%
- REIT – 9%
So now that you’ve been formally introduced to the JC Chasez of real estate investing, you can stop waiting around until you have enough money saved for a down payment or dreading the responsibility of managing tenants yourself. Just add a REIT to your portfolio instead and reap the rewards of a steady income and property appreciation while skipping the headache of dealing with noise complaints.
Want to buy an investment property of your own? The book Hold will guide you through the entire process. From finding a realtor and accountant, to exact instructions on how to evaluate a property so you can start making money on day 1. It’s the book I’ve been using to start my real estate investing journey, and I can’t recommend it enough! Get it here!
*Disclosure: I get commissions for purchases made through some links in this post.