Understanding Different Risks of Investing in REITs
February 27, 2023
Every type of investment comes with its own set of risks and when you consider investing in real estate investment trusts (REITs), you must be aware of the risks associated with it. REITs are investment equities you invest in to increase the returns on your portfolio. It is very different from investing in real estate directly. REITs are investments that own and manage various commercial properties. They distribute a majority of their net revenues in the form of dividends to the shareholders.
REITs make an ideal investment opportunity if you are looking for consistent income and want exposure to the real estate industry. Before you jump in at this opportunity, let us take a look at the different types of risks you should be aware of.
Overall, is Investing in REITs Risky?
Investing in REITs is a good way to generate passive income but it comes with a risk. Your return will depend on the type of REIT you have invested in and not all REITs pay dividends. Use sound risk management strategies when investing in them because there are many fraudulent REITs and it is not easy to spot them. You will find two types of REITs- publicly traded and private REITs. Research well and analyze their financial documents before you invest. Remember to diversify your portfolio so that the risk is spread out. There is a risk but with a little research and caution, there are chances of enjoying high returns on low risk REITs.
Now let us take a look at the risks associated with publicly traded REITs.
The Risks of Publicly Traded Reits
Before investing in publicly traded REITs, you must be aware of the risks associated with them. That said, since they are more exposed to market-wide risk due to the dependence on global economic trends, you should be very careful when choosing a REIT. It should fit your needs and to carefully pick the right one, you should have an understanding of all the risks present.
Understand the impact of each risk and then develop an investment strategy that helps mitigate potential losses. Here are some risks of investing in REITs.
Interest Rate Risk
Interest rate risk can have an impact on the returns from a REIT. Whenever the rates drop, it will lead to a drop in the demand for REITs which will make the investment less attractive.
Choosing the Wrong REIT
Investing in the wrong REIT could mean lower returns or loss of money. Careful selection as per your needs is very crucial.
The impact of tax can affect the profitability and growth potential which is why you should be aware of how the investment will be taxed before you invest in one.
Any change in the market legislation related to REITs will impact your returns.
Publicly traded REITs have exposure to the wider market and are impacted by global economic conditions.
Concerns about the environment related to a certain sector or REIT can hurt your returns.
Tenant Performance Risk
A default by the tenant or tenant performance will impact your rental income and it could lower returns for investors.
Now that we’ve seen the risk of REITs, let us take a look at the risks of privately traded REITs.
Risks of Privately Traded REITs
Private REITs are also known as non-traded REITs and investing in them comes with a set of risks you should be aware of. Their value will be subject to the market and can often fluctuate. Private REITs do not trade on exchanges which means you have limited liquidity when it comes to your funds. You also have to consider the high fees that will impact your returns and the distributions are not guaranteed. Always conduct thorough research and then invest so as to reduce the potential for loss. Here are the risks associated with private REIT investing.
Examples of risks of Private REIT Investing include:
The share value of your REIT is subject to market movement and will often fluctuate and this can lead to losses.
Lack of Liquidity
Since private REITs do not trade on an exchange, you will have low liquidity when it comes to accessing your funds.
There is no guarantee about the distributions.
You will have to pay high fees for private REITs and this will impact your returns.
You will pay close to 1-3% of your total investment as management fees when you invest in a private REIT. You have to pay these fees regardless of the fund’s performance.
Many REITs have repayment fees and you will have to pay them when you sell your shares in a certain period. It might reduce the gains you have made.
REITs can be a great way to generate passive income but you must understand the risks before you proceed. If you are looking for a way to invest in commercial real estate REIT, consider CRE Income Fund. You can get all the details on our website.