Real Estate Investment Trusts (REIT)
Investing in real estate can be quite profitable. It can, at times, be more beneficial than other forms of investing holdings such as stocks or bonds.
However, directly investing in real estate can be a bit laborious and expensive. Surveying the market for available properties can take up a lot of time. Additionally, the whole transaction process can take a long while to complete. A Real Estate Investment Trust (REIT) is the solution for those of you who want to invest in real estate but don’t have a large sum of money.
If you don’t know what a REIT is, don’t stress. We will talk about all the details you need to know about REITs. So, let’s have a closer look.
What is a Real Estate Investment Trust (REIT)?
A Real Estate Investment Trust, or REIT for short, is a company that allows multiple investors to stockpile their money to invest in different types of real estate. Most REITs focus on particular sectors of real estate, but others cover multiple sectors.
However, be it diversified or specialty REITs, both offer a wide variety of properties in their portfolios. This can include warehouses, hotels, apartment complexes, healthcare facilities, and retail centers. This means you also have an option to diversify your real estate investments.
With REITs, investors are given shares and get a proportional percentage of the interest generated through the income and assets of the investment firm. While directly investing in real estate properties requires a large sum of money, REITs allow you to invest in real estate properties with even a modest amount.
Introduced in the United States in 1960, REITs were designed to allow the average citizen to attain income by investing in commercial real estate. This way, investors can earn income through rent without completely owning the property.
How Do REITs Work?
Following a simple business model structure, REITs offer a space for rent, and then they collect and distribute the income as shares among the investors. For a firm to qualify as a REIT, it needs to comply with the Internal Revenue Code.
Some of the specific requirements that the REITs must meet are:
- Investment of at least 75% of its total assets must be in real estate.
- The source of at least 75% of its gross income must be from real estate.
- Investors should get 90% of their taxable income as dividends to its shareholders.
- After a year of establishment, it must have at least 100 shareholders.
- It must not have five or fewer individuals holding more than 50% of shares by the latter half of the taxable year.
- Like corporations, it should be taxable to the IRS.
- A board of directors or trustees.
Different Types of REITs
As an investor, you have the opportunity to pick from various types of REITs. REITs are classified according to the sort of business they conduct and how they generate income. So, the whole buying and selling process comes into play.
Regulated by the U.S. Securities and Exchange Commission (SEC), Publicly Traded REITs are listed on a stock exchange, similar to public companies. These offer investors the benefit of liquidity as you can trade freely on an exchange. However, this liquidity is tied by a liquidity premium to the value of stocks. This might mean a low return rate for investors, as the value might fluctuate depending on the stock market.
Publicly non-traded REITs have caught the public’s eye due to the double-digit shares distributed among investors. However, the large advance fee that is often taken from investors and the ambiguity that surrounds it has caused some scrutiny from the public. The SEC’s Investor Bulletin claims that some non-traded REIT advance fees can be equivalent to around 15% of your initial investment, making it one of the highest fees in the financial sector.
Not registered with the SEC, Private REITs are not tradeable on national securities exchange platforms. These companies function privately and only sell to their list of private investors. Such investment companies are also not bound by the same regulations as those REITs that are on the stock exchange.
Equity REITs are more involved in the ownership, management, and expansion of commercial assets. Most of the income comes from rent payments. There is rarely any reselling of assets involved with these REITs. These can be either diversified or specialty REITs. They invest mostly in retail, office, residential, industrial, and hotel properties.
Mortgage REITs have ownership of real estate debt, which means their main source of income comes from the net interest margin. The net interest margin refers to both the interest acquired through the mortgage loan and the funds invested in these loans.
Money is lent either through loans and mortgages, or it is done through the purchase of mortgage-backed securities (MBS). MBS refers to the various investment holdings that the government-sponsored enterprises (GSEs) supplies. Since these REITs pivot around mortgages, they are vulnerable to the changes in interest rates.
Hybrid REITS utilize both real estate property and mortgage loans. Usually, such companies lean towards one side more. So, they’ll either focus more on rental properties or mortgage loans. Such companies not only benefit from both forms of investments, but the risk also runs low in comparison to investing in only one sort.
The Advantages and Disadvantages of Investing in REITs
Whether you’re investing in stocks, bonds, or real estate, they all have their pros and cons. Let’s take a look at some of the advantages and disadvantages of REITs.
One plus of REITs is that they’re pretty simple to purchase and sell, as almost all REITs are tradable on the public exchange. This reduces the challenges faced by traditional forms of investment in real estate.
Furthermore, conventional real estate is illiquid, so it can take a long time for you to purchase or sell properties. It also veils a lot from investors because you don’t always know if information related to taxes and ownership is accurate or not. REITs, on the other hand, are constantly regulated by the SEC and are required to submit audited financial reports.
In terms of its performance, REITs provide investors with a risk-adjusted and steady flow of returns. Moreover, REITs can help diversify your portfolio with different assets.
One of the major drawbacks of REITs is that they are sensitive to the fluctuating market. As is the case with most investment holdings, REITs also don’t come with 100% profit assurance, and neither do they protect you from losses. In some cases, you may have to pay high up-front or transaction fees.
There also isn’t much room for capital gain. As 90% of income is returned to investors as dividends, the enterprise can reinvest only 10% of the remaining taxable income for purchasing new property.
- Allows for liquidity
- More transparency in comparison to traditional forms of investment
- There is risk-adjustment of returns
- Help diversify your portfolio
- Stable cash flow
- Little room for capital gain
- Dependent on market fluctuations
- High transaction and management fees
How Can You Invest in REITs?
If you want to invest in REITs, you can take into consideration publicly-traded REITs, REIT mutual funds, and REIT exchange-traded funds. You can invest in these by buying funds from brokers. If you’re more interested in non-traded REITs, we suggest looking for a financial advisor or broker who specializes in the non-traded REITs.
Nowadays, REITs are also a part of employer-sponsored retirement plans, be it defined-benefit or defined-contribution. According to research conducted by Nareit, a research and advocacy firm in the U.S., approximately 80 million investors in the U.S. possess REITs vias retirement plans and other investment funds.
We also suggest looking into the track records and the management board to find out how they’re remunerated. If the firm is focused on performance, they’ll probably be working to incorporate the best strategies and to invest in good properties. Keeping up to date with the company numbers is also very useful. Check the predicted growth in earnings per share (EPS) and the current income flow.
Two helpful metrics to glance at are the REIT’s funds from operation (FFO) and the Financial Management Rate of Return (FMRR). The former measures the income flow produced through the assets of the REIT. The latter evaluates the performance of the investment done by the REIT.
Which REIT Sector Should You Choose?
An important factor to take into account when investing in a REIT is to see which real estate sectors are currently booming. Just think of general economic sectors that do well in the market and can be accessed through real estate. For instance, you can take into consideration the health sector in the U.S., which is developing fast and can provide a stable source of capital.
REIT is a good option for people who just want to invest in real estate and don’t want to manage anything. For example, you don’t have to worry about landlord duties because the REIT does the job for you. They manage, purchase and do the bookkeeping for you. Moreover, you can even buy shares with a modest investment and get dividends from the rental payment.
For people who don’t want to go through the hassles of traditional forms of investment, REITs are a great option. By now, you should know everything there is to know about REITs. We suggest you weigh your options and decide what to do with your money.