An alternative way to own an alternative asset.
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Thereâs an old saying that goes, âBuy land, theyâre not making it anymore.â But purchasing real estate often requires a lot of money, tying up capital in an asset that might not be easy to sell. Plus, thereâs the hassle of maintaining a physical asset and being a landlord if you rent or lease it.
There are other ways to own real estate without owning land by investing in real estate companies or real estate investment trusts (REITs). The benefits of investing in the real estate sector include diversification and income generation, but changes in interest rates and regulations can adversely affect your holdings.
Key Points
- Real estate investment trusts (REITs) own and manage many property types, from residential housing to warehouses to high-rise buildings.
- REITs are popular with income investors because of their high dividends.
- The underlying value of the property drives a REITâs value.
The real estate market is expansive, covering everything from residential housing to hotels, hospitals, warehousesâeven cell phone towers, and of course land. In 2023, the U.S. residential real estate market was worth $43.5 trillion, according to research firm CoreLogic, while the Federal Reserve Bank of St. Louis estimated the value of U.S. commercial real estate at $22.5 trillion.
What is the real estate sector?
Real estate is one of 11 sectors defined by the Global Industry Classification Standard (GICS). Itâs also one of the newest (it was added in 2016), and one of the smallest, comprising 2.3% of the GICS. That puts it just above the materials sector at 2.2% as of mid-2024.
Most of the industry and subindustry groups within this sector are investable as REITs, which are publicly traded holding companies that own and manage properties and collect rent. They include:
- Diversified REITs. These companies own and manage a mix of property types, such as industrial and office properties. Examples include American Assets Trust, Inc. (AAT) and Broadstone Net Lease, Inc. (BNL).
- Industrial REITs. Warehouse and distribution centers comprise some of the facilities in this subgroup. Public Storage (PSA) and Prologis, Inc. (PLD) are two well-known industrial REITs.
- Hotel and resort REITs. When you look for a place to stay, itâs likely owned by a REIT. Many familiar hotel franchises, such as Hilton and Marriott, are owned by REITs. Publicly traded REITs include Ashford Hospitality Trust, Inc. (AHT) and Host Hotels & Resorts, Inc. (HST).
- Office REITs. This subgroup includes skyscrapers and office parks. Some may specialize in certain locations, such as central business districts or suburbs. Examples include Brandywine Realty Trust (BDN) and City Office REIT, Inc. (CIO).
- Health care REITs. These companies own hospitals, medical office buildings, and senior living facilities. CareTrust REIT, Inc. (CTRE) and Community Healthcare Trust Inc. (CHCT) are two examples.
- Residential REITs. This group comprises multifamily and single-family residential REITs, including apartment buildings, student housing, and manufactured homes. Essex Property Trust, Inc. (ESS) and NexPoint Residential Trust, Inc. (NXRT) are two.
- Retail REITs. Think shopping malls, outlet malls, and strip malls with grocery or big-box retailers as anchors. Simon Property Group, Inc. (SPG) and Realty Income Corp. (O) are market-cap leaders in this subsector.
Other REITs, such as those focused on mortgages and farmland, arenât included in the official GICS definition.
A handful of real estate companies in the sector arenât REITs. They include RE/MAX Holdings, Inc. (RMAX); real estate services company CBRE Group, Inc. (CBRE); and Murano Global Investments PLC (MRNO), which owns and develops properties in Mexico.
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Some companies operate in the real estate realm but donât fall under the GICS real estate classification. Among them is Zillow Group, Inc. (Z), an online real estate information provider, which is included in the communication services sector.
What makes the real estate sector distinctive
Real estate is a unique investment class, as it mostly includes properties. Other aspects also make it stand out:
- Tangible. Exchange-listed REITs trade like stocks but own physical assets.
- Pay high dividends. REITs must distribute at least 90% of their taxable income to shareholders annually, according to Internal Revenue Service (IRS) rules. REIT dividends come from rents paid by the tenants of their properties.
- Inflation hedge. When prices climb, real assets such as real estate often rise to keep up.
- Land values are key. The underlying property value is paramount to any REITâs success. If land values fall, the sector may see demand soften.
Tips for investing in the real estate sector
Investors need to watch several factors that influence the real estate sector:
- Economic indicators. A growing economy can raise demand for more housing, increase retail spending, and spur consumers to travel more. Conversely, a recession may cause job losses and reduce discretionary spending, which affects tenantsâ ability to pay rent.
- Interest rate sensitivity. Thereâs a dichotomy in how changes in interest rates affect real estate. Interest rate changes cause mortgage costs to rise and fall, affecting borrowing costs, property affordability, and investment returns. If rates climb because inflation is rising, REIT values tend to follow.
- Regional and economic issues. The economic factors that drive residential REITs may not affect hospital REITs. Also, some REITs specialize in different parts of the country. All real estate is local and affected by local economic trends, and thatâs also true for REITs.
- Regulations. Land use is heavily regulated, so be aware of zoning issues and other government changes.
- Tax considerations. REIT dividends are typically treated as ordinary income. They donât get the same special treatment of reduced taxes that you might get on other types of corporate dividends.
- Ways to invest. You can invest in individual REITs or in REIT-themed mutual funds or exchange-traded funds (ETFs). Individual REITs provide targeted exposure but have the same type of risk as buying a single stock. Funds offer diversification, but they also charge fees.
Exploring investment alternatives
Investors who are looking to diversify their investment portfolios but donât want to own property may find buying stocks in the real estate sector attractive.
Companies in the sector are grouped by the types of properties they own and manage, allowing investors to zero in on investment themes and ideas. Real estate is sensitive to economic conditions, demographics, and interest rates. These are factors to keep in mind if youâre considering adding publicly traded land and building investments to your portfolio.
Specific companies and funds are mentioned in this article for educational purposes only and not as an endorsement.
This article was most recently revised and updated by Debbie CarlsonThis article was most recently revised and updated by David Schepp
