What Are Specialty REITs? How to Invest in Them

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Key Points Real estate investment trusts (REITs) are a special type of real estate company required to pay out dividends to investors. Specialty REITs combine market specification with dividend income, making them an appealing choice for some investors looking for hands-off real estate investing. Learn the answer to "what are specialty REITs?" and how to invest in them with MarketBeat. 5 stocks we like better than EXA) Real estate investment trusts (REITs) are special real estate companies operating and maintaining commercial and residential properties. REITs are attractive to income investors because they are one of the only types of stocks required to pay out a regular dividend to investors. But did you know that you can also invest in specialized REITs to diversify your passive income streams? Before you invest in a REIT, consider the sector you're investing in. Read on to learn more about specialty REITs, how they work and the pros and cons of investing in these real estate operations. What is a Specialty REIT? Before discussing a specialty REIT and looking at examples, defining a REIT and why these companies differ from other real estate stocks is important. A real estate investment trust (REIT) is a special type of real estate company that purchases and operates commercial real estate or rented residential properties. Most REITs operate relatively straightforwardly, purchasing and maintaining rental properties and collecting tenant income. Some REITs are also involved in mortgage purchasing and home financing. What sets REITs apart from other companies is their unique tax structure and obligation to distribute a significant portion of their earnings to shareholders as dividends. To qualify as a REIT, a company must meet certain criteria set by the federal government and oversight bodies like the Securities Exchange Commission (SEC). One of these requirements is that REITs must distribute at least 90% of their taxable income back to shareholders as dividends. These recurring and required dividend payments are one of the REITs' main appeals, creating a reliable stream of passive income. As the name suggests, specialty REITs are a subset of REITs that focus on investing in specialized real estate properties and assets. These companies invest in "themed" portfolios of real estate assets within a specific industry or providing a specific type of real estate. Some types of specialty REITs you can invest in include the following. Healthcare REITs: Healthcare REITs invest in various healthcare-related properties such as hospitals, medical centers, senior housing facilities, skilled nursing homes and assisted living communities. The demand for these healthcare facilities tends to be relatively stable, driven by the aging population and healthcare needs. This makes them popular for investors looking for a REIT subset with more consistent future product needs. Commercial retail REITs: These REITs invest in properties related to retail and commercial spaces, including shopping malls, outlets and standalone retail buildings. Consumer spending trends and the overall health of the retail and consumer discretionary sectors can influence the performance of retail REITs. Data center REITs: Data management and cloud computing require large-scale server centers. Data center REITs are a type of specialty REIT that maintain and operate server centers and may also provide internet and cloud computing services to complement customers' businesses. Additional types of specialized REITs include office REITs, hospitality and hotel REITs and infrastructure REITs. Like specialized stocks, you can also invest in a specialty REIT ETF that incorporates multiple REITs from within a particular industry or sector into a single investment. These speciality funds provide a quick and convenient way to gain exposure to multiple REITs with a single buy order. How Do Specialty REITs Work? Specialty REITs acquire and own real estate properties to generate rental income like other REITs. However, their focus is limited to a particular niche within the real estate market, such as healthcare facilities, data centers or retail operations. Specialty REIT managers begin by identifying and scouting new real estate opportunities within the sector that they operate in. They then use an in-house process to determine investments that qualify for inclusion in their holdings and purchase the properties. The primary source of income for REIT specialty types comes from the rental payments received from tenants using their properties. For example, a healthcare REIT would earn income from healthcare providers leasing medical facilities, while an industrial REIT would generate revenue from warehouse or distribution center tenants. The REIT collects these payments in exchange for maintaining and managing the commercial space, which are then distributed to investors as dividends. How to Invest in Specialty REITs Most REIT speciality companies trade on major stock exchanges using the same method as any other share of stock. If you're interested in buying and selling shares of specialty REITs, use the basic steps below to get started. Step 1: Select a sector. The first step to investing in specialty REITs is determining which industry you want to invest in. Consider your overall investment objectives, time horizon and risk tolerance when selecting which types of specialty REITs to include in your portfolio. Different specialty REIT sectors come with varying levels of risk and potential for returns. For example, healthcare REITs might offer more stability due to essential services, while data center REITs might present higher growth potential and increased volatility. Consider factors like income potential, current economic conditions and supply/demand dynamics when selecting which specialty industry to focus on. MarketBeat's list of the top market REITs can help you identify thriving sectors in the REIT industry. You should combine multiple companies within a single sector by investing in a specialty REIT ETF over individual companies to spread your risk out between more operations. Step 2: Open a brokerage account. The next step is to open a brokerage account after deciding which specialty REIT sectors you're interested in investing in. Brokerage accounts are intermediary accounts that connect you with a licensed stockbroker authorized to buy and sell assets on behalf of clients. Most brokers now allow new clients to create a brokerage account from the comfort of their home with an I.D. and link to a funding account. If you're a resident of the United States, you have dozens of options when it comes to opening your first brokerage account. Examples of popular brokers include Robinhood, Charles Schwab, E*Trade and T.D. Ameritrade. Some of the factors you might want to consider when selecting a broker can include: REIT and market availability Types of accounts (taxable brokerage, IRA , self-directed 401(k), etc.) Commissions and account fees Trading platform and tools After opening your account, you'll need to link a funding source before you can buy or sell assets. This may take a few days to confirm fully — use this time to explore market resources and track the items you're considering buying. After funding your account, you can place a buy order for the shares you're interested in. Step 3: Monitor your investment and manage dividends. If your broker can complete your buy order, you'll see your shares in your brokerage account. From here, you'll be responsible for monitoring your shares' values and deciding how long you want to hold your assets. You'll also need to decide how to manage your dividend payments. Most brokers allow you to take your dividends in cash using your linked funding method for deposit, but you can also sign up for a dividend reinvestment program with most assets. When you enable dividend reinvestment, dividends are automatically reinvested in the company that issued them. This can be a more convenient way to grow your holdings over time. Example of a Specialty REIT A quintessential example of a specialty REIT is data center giant Digital Realty Trust NYSE: DLR. Digital Realty is a global company focusing its investment portfolio only on data centers, with operations in South Africa to Greece. The company sets itself apart from competing data center REITs with its PlatformDIGITALR service, which streamlines customer data processing. Digital Realty Trust has a total market capitalization of $35 billion, making it a major player in the data center REIT arena. Image text: While DLR's 4% dividend yield isn't the highest on the market, its payments have risen consistently for the past two decades. Pros and Cons of Specialty REITs Specialty REITs are unique assets, and you'll need to consider both the pros and cons before investing. Pros Specialty REITs allow you to combine an eye toward real estate with a particular sector an investor believes is primed for a strong future. Focused exposure: Specialty REITs allow investors to concentrate their exposure in specific real estate sectors, providing targeted exposure to industries with potential growth opportunities. This focused approach can appeal to those with a strong conviction about a particular sector's future prospects. Specialized dividends: Many specialty REITs focus on sectors with stable demand, such as healthcare facilities, which can lead to consistent rental income. This makes specialty REITs attractive for income-focused investors looking for regular dividends. Diversification within the real estate investment sphere: You can diversify your real estate holdings by investing in specialty REITs across different sectors. This diversification can mitigate risk compared to owning individual properties directly. Cons Drawbacks of REITs can include heavy concentration in a single sector and the risk of volatility and future dividend cuts. Sector-specific risks: Specialty REITs are exposed to the risks inherent to their chosen sectors. For example, regulatory changes may affect healthcare REITs, while retail REITs could face challenges due to shifts in consumer behavior. This can cause concentrated losses if all your specialty REIT investments are in the same sector. Lack of diversification: Most specialty REITs invest exclusively in a single sector or area of real estate, which can make them riskier investments due to a lack of diversification. REIT Alternatives REITs aren't the only way to invest in real estate. Some common alternatives to REITs might include: Investments in real estate-related stocks: REITs aren't the only stock that deals with real estate. Investing in supplementary companies and sectors can complement REIT investments. Crowdfunding: Real estate crowdfunding platforms allow investors to pool their funds to invest in various real estate projects, allowing each investor to see a higher return on investment. This option provides opportunities to invest in specific properties or projects with lower capital requirements when compared to direct personal investments. Direct investments: Investing directly in real estate might mean purchasing homes and flipping them or renting these spaces out to tenants. Of course, this investment method provides more direct control but comes with high upfront requirements. Should You Invest in REITs for Dividends? REITs are attractive investment options for those looking to create dividend income streams. While it's true that REITs show some of the highest dividend yields when compared to other stocks, these high yields may sometimes create a dividend trap for investors, cutting dividends shortly after a stock's price dips. Examine dividend history and the number of consecutive years the stock has raised its dividend to ensure you make smart long-term choices about these specialty funds. FAQs What are specialty REITs, and how do they influence your portfolio? If you have last-minute questions about specialty REITs, the following FAQ will clear them up before you invest. What is the highest-paying REIT? The company that pays the highest dividend yield percentage may vary depending on stock price volatility and market changes. Orchid Island Capital NYSE: ORC is one of the largest major REITs with a high dividend. The company maintains a dividend yield of about 18%, higher than competitors. What are the top five REITs? The top five REITs in order of market capitalization are Prologis NYSE: PLD, American Tower NYSE: AMT, Equinix NASDAQ: EQIX, Public Storage NYSE: PSA and Crown Castle NYSE: CCI. These companies all showcase market capitalization of at least $45 billion and trade on major exchanges like normal shares of stock. Why do investors buy REITs? There are many reasons why an investor might want to add REITs to their portfolio. These companies are one of the only types required to pay out dividends to investors, creating a reliable stream of passive income. These investments also offer a way to gain exposure to the real estate market without the responsibilities of a direct property investment.