There are several ways to invest in real estate, and real estate investment trusts, or REITs, are one of the most popular. They allow investors to put their money to work in large portfolios of commercial real estate assets without any active involvement in the day-to-day operations and can be a great way to achieve both growth and income over time.
However, there's far more to the world of REITs than the publicly-traded variety that many investors are most familiar with. An eREIT is a relatively new concept in the field of real estate investing. Here's what investors should know about REITs vs. eREITs so they can decide whether eREITs are a good fit.
What is a REIT?
A real estate investment trust, or REIT (pronounced "reet"), is a specialized type of company designed to invest in real estate assets. However, not every company that invests in, operates, develops, or manages real estate assets can call itself a REIT. Before it can officially become a REIT, certain criteria must be met, including:
- REITs must pay at least 90% of their taxable income to shareholders. This is perhaps the best-known characteristic of REITs, and because of this requirement, REITs are treated as pass-through entities for tax purposes (more on that later).
- REITs must invest at least 75% of their assets in real estate investments. This doesn't necessarily mean that they need to own properties. In fact, some REITs exclusively buy mortgages and other financial investments.
- REITs must have at least 100 shareholders. Because of this requirement, many REITs start out as partnerships or general corporations until they build up a shareholder base. And no five shareholders can own more than 50% of any REIT.
You might be wondering why a company would go through this trouble. The answer has to do with taxes.
REITs have a unique tax structure
If a company meets all the above requirements and elects to be treated as a REIT, it gets to enjoy a unique tax structure.
In addition to the standard tax advantages of real estate investing, such as depreciation, REITs are not taxed on the corporate level whatsoever. Because they are required to distribute virtually all of their taxable net income, REIT distributions are considered pass-through income and are only taxed on the individual level.
This is a big benefit. Most dividend-paying stocks are effectively taxed twice. The company pays corporate tax when it initially earns its profit, and then its shareholders pay tax again on whatever portion of the profits the company chooses to pay as dividends.
And while REIT dividends typically don't get the same favorable tax rates that most stock dividends do, they qualify for the 20% pass-through tax deduction that was created as part of the Tax Cuts and Jobs Act, which helps level the playing field.
The 3 types of REITs
When it comes to investment structure, there are three main types of REITs that investors should be aware of:
- Publicly-traded REITs: These are REITs that trade on major stock exchanges and can be readily bought and sold on the open market by any investors.
- Public non-listed REITs: These are REITs that are open to any qualified investor but don't trade on major stock exchanges. Instead, you invest in them directly with the management company or through a third-party investment broker.
- Private REITs: These REITs aren't open to public investment and don't trade on major stock exchanges.
What is an eREIT?
First of all, an eREIT is a subcategory of REIT. In other words, all eREITs are REITs, but not all REITs are necessarily eREITs.
Second, eREITs aren't exactly their own category of REIT. Rather, "eREIT" is a trademarked term that refers to REITs sponsored by real estate investment platform Fundrise (or specifically, its parent company, Rise Companies Corp.).
Technically, Fundrise's eREITs are in the public non-traded REIT category. They aren't traded on major stock exchanges, but they are open to all investors. The major differentiator between eREITs and most other public non-traded REITs is that eREITs are sold directly by Fundrise -- in other words, there are no brokers involved (and therefore no sales commissions).
There are several eREITs investors can choose from, and each one invests in a certain type of commercial real estate and has a geographic focus. And as with any investment, there are pros and cons involved with eREIT investing. Let's take a closer look.
Currently, Fundrise offers four different investment portfolio options, each of which invests in a combination of the company's eREITs offerings:
- Starter Plan: Designed to be a basic and diverse way for beginners to invest in real estate, this plan invests half of its money in the company's growth eREITs and the other half in income-focused eREITs. Because it's designed for beginners, the starter plan only has a $500 minimum investment requirement.
- Supplemental income: This plan is designed to produce steady, high income, with long-term equity appreciation being a secondary goal. The eREITs invested in the supplemental income plan have 27 active investments, with most of them in the form of debt assets.
- Balanced investing: This investment plan aims to strike a nice balance between growth and income, with both debt and equity real estate assets held in the eREITs it allocates investor capital to.
- Long-term growth: Finally, this plan aims to achieve superior long-term growth with dividend yield being a secondary focus. Most of its assets are allocated to equity investments, with a particular focus on value-add and development projects.
Pros of eREIT investing
The lack of sales commissions gives eREITs a major advantage over other non-traded REITs. In fact, it's not uncommon for upfront costs of non-traded REITs to consume as much as 15% of your initial investment.
In fact, although eREITs have some fees and expenses associated with them, the costs are much less than comparable alternatives. While there are no sales commissions, Fundrise expects each eREIT to have initial expenses of about 3% of invested capital and ongoing management fees of 1% (all-in), which is much lower than the typical non-traded REIT.
Perhaps the most compelling reason to consider eREITs is for their superior return potential. Because they don't command the liquidity premium of publicly-traded REITs and have superior fee structures to non-traded REITs, they have higher income and total return potential. In fact, one of Fundrise's eREITs initiated an 8.25% dividend yield in 2017, and Fundrise's total returns have beaten the REIT benchmark index in four of the past five full years.
Cons of eREIT investing
Liquidity is a concern for prospective eREIT investors. With publicly-traded REITs, you can sell your shares at any time for full market value with the simple click of a mouse. Meanwhile, Fundrise's investment products only have monthly redemption options, and there are limitations that may prevent shares from being redeemed.
Each eREIT typically has a minimum investment amount of $1,000. While this is often superior to non-traded REITs, it's important to mention that publicly-traded REITs can be bought for as little as the price of one share.
The bottom line on eREITs
eREITs are a solid alternative to publicly-traded REITs as well as other non-traded REIT options. There are some downsides that should be considered, and eREITs are likely not the best choice for investors who want the ability to sell their investments whenever they want or who want to monitor the day-to-day changes in market value. However, they can be a great way to passively invest in real estate for diversification, income, or long-term growth purposes.