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The Best Way to Invest in Real Estate

If you think profiting from residential real estate requires lots of elbow grease, or dabbling in commercial real estate is beyond your financial means, you probably aren't familiar with real estate investment trust (REIT) investing. REITs come in all shapes and sizes, but they all have a few things in common. They trade on major exchanges just like common stocks, but unlike regular companies, they avoid taxation as long as they distribute nearly all of their profits to you, the shareholder.

Buying and selling shares through an online brokerage account is easier than finding a washed-up celebrity flipping houses on television, but simplicity is just one advantage REITs have over directly investing in real estate. Here's a look at a few more benefits this asset class provides individual investors that you probably won't hear about from Vanilla Ice. 

REIT investing allows individual investors to expand beyond the residential-property sphere. Image source: Getty Images.

The wide world of REIT investing

Hands down, the best reason to buy REIT shares is the vast array of real estate subsectors they open up to an individual. If you'd rather collect rent from Walgreens and FedEx than a complete stranger who could lose their job, buying shares of Realty Income Corp (NYSE: O) allows you to do just that. This REIT boasts a portfolio of 5,000 commercial properties across the country and, at the end of June, 98.5% of them were occupied by companies you're probably familiar with. Few individuals could finance just one commercial property, but buying just one Realty Income share for about $57 at recent prices entitles you to a slice of the profits this behemoth generates.

If you're concerned about shifting consumer habits, you'll be glad to know there are REITs that allow you to ride practically any real estate trend you can think of. For example, Outfront Media's portfolio contains over 400,000 billboards throughout the country, and Extra Space Storage owns 1,441 self-storage properties across 38 states.

REIT Name Ticker Symbol Sector Specialty Dividend Yield Market Cap
Realty Income Corp O Commercial 4.4% $15.6 billion
Outfront Media OUT Billboards 6.3% $3.2 billion
Extra Space Storage EXR Self-storage 4% $10.0 billion
Omega Healthcare Investors Inc OHI Healthcare 8.2% $6.2 billion

One of the most important under-the-radar trends you can follow with REIT investing is a rapidly aging demographic in the U.S. and other developed nations. Roughly 10,000 baby boomers turn 65 each day, and demand for skilled nursing and long-term care facilities is widely expected to rise, right along with the average age of Americans. This is one reason I own shares of Omega Healthcare Investors (NYSE: OHI) that I'll probably never sell.

Triple-net effect

We can reasonably expect demand for properties in the Omega Healthcare Investors portfolio to rise, but the underlying profitability of the operators that lease these facilities is subject to fluctuating insurance rates, unforeseen maintenance issues, and property-tax hikes. This is why I look for REITs that collect rent through triple-net leases, which require their tenants to absorb these expenses.

Triple-net leases help Realty Income, Omega Healthcare, and plenty of their peers to generate a steadier income stream than an individual renting their own properties could ever dream of. In turn, these predictable cash flows allow these REITs to raise lots of capital to expand their property portfolios at lower interest rates.

REITs and Roth IRAs

Another huge advantage REIT investors enjoy is a near lack of taxation. As an individual, you need to pay taxes on rental income if you take that route, or capital gains if you sell a fixer-upper at a profit. REITs, on the other hand, avoid the taxes as long as they distribute at least 90% of their profits to shareholders in the form of dividends.

As a shareholder, dividends received from REITs are taxed as ordinary income, which is generally a much higher rate than you would pay on dividends received from ordinary corporations. Luckily there's an easy way to avoid REIT dividend taxes until you're ready to retire.

Holding REIT shares and common stocks in a Roth IRA allows the dividends they send your way to accumulate outside of the taxman's grasp. As long as you wait until you're 59.5 years old before you begin making withdrawals from your Roth IRA, profits generated by the REIT you own are essentially tax free.

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Cory Renauer owns shares of Omega Healthcare Investors and Realty Income. The Motley Fool recommends FedEx. The Motley Fool has a disclosure policy.