What is a REIT?
REITs, or real estate investment trusts, are a type of real estate investment vehicle that collects money from many investors to buy large amounts of commercial, industrial or residential real estate. They were first created in 1960 to help small investors access larger investments without having to have a high initial capital.
Today, REITs are one of the most popular ways to invest in real estate, both for individuals and institutions, as they offer high returns and reduced risks due to their unique operating structure.
A REIT is a company that owns or manages a portfolio of real estate property to generate income through rents. REITs can also buy plots of land, develop real estate projects and subsequently sell the properties, generating capital gains (or losses) for the investors; these however are usually one-time events and generally do not have a long-term effect on a REIT’s future earnings potential.
These properties may include office buildings, apartments, hotels, hospitals, shopping malls, medical centres, hotels and warehouses. Some REITs focus on only one type of industry, such as residential, commercial, and healthcare, while others hold properties of various types in their portfolios.
Unlike other real estate investment instruments, REITs are listed on the stock exchange and are therefore accessible to all investors, even those with limited budgets.
REITs represent a high-yield asset class and their potential shows no signs of running out. With more than a third of global wealth held in physical real estate, the real estate market is a sector of great economic importance. REITs offer a way to access this market in a liquid and diversified way.
In general, REITs are an attractive option for investors who want to add real estate exposure to their portfolios without the high costs and management responsibilities associated with direct investments. REIT shareholders therefore benefit from a portion of the rental income generated, without having to directly buy, manage or finance real estate.
To qualify as a REIT in the United States, a company must meet several criteria:
- Invest at least 75% of assets in real estate;
- Derive at least 75% of gross income from rents, mortgage interest or real estate sales;
- Pay at least 90% of taxable income in the form of shareholder dividends;
- Be a taxable company;
- Be managed by a board of directors or trustees;
- Have at least 100 shareholders after one year of operation;
- At least 50% of its shares must be held by five or more people.
Types of REITs
There are different types of REITs, each with its own characteristics and objectives.
Equity REITs own and manage physical properties such as offices, apartments, hotels and industrial buildings. These REITs generate income through rents received from properties in their portfolios. In addition, they tend to be more stable investments than individual real estate properties and are often less correlated with stock market volatility, making them a popular choice for diversification and risk management among both professional and individual investors.
Mortgage REITs derive most of their profits from owning and operating mortgages rather than physical real estate. Unlike equity REITs, these REITs do not pay dividends directly but offer higher returns than traditional stocks due to the high levels of leverage involved in their trades.
Hybrid REITs combine equity and mortgage elements to create a more balanced investment portfolio.
How to invest in REITs?
If you are interested in investing in REITs, several options are available. The first is to invest directly in a REIT by purchasing shares or shares on the open market through an online brokerage account. In addition, many financial advisors or Robo Advisors also offer access to individual REITs as part of their investment management services.
Real Estate Investment Alternatives to REITs
ETFs
There are several exchange-traded funds (ETFs) that focus specifically on real estate investments, which can be an effective way for investors with smaller portfolios or limited capital to gain diversified exposure to this asset class without having to select individual companies. Here are some examples:
- iShares Cohen & Steers REIT ETF (ICF)
- iShares Global REIT ETF (REET)
- Invesco KBW Premium Yield Equity REIT ETF (KBWY)
Stocks
These are some stocks involved with real estate:
- Equity Residential (EQR) is a large real estate company that focuses on rental properties such as apartments and condos. With a market capitalization of nearly $25 billion, EQR is well positioned to seize the opportunities of the current real estate market thanks to its strong balance sheet and diversified property portfolio.
- Vornado Realty Trust (VNO) is a real estate investment trust that owns and manages commercial, office and multifamily real estate throughout the United States. With over 100 million square feet of world-class retail space in some of the country’s most dynamic markets, VNO is well-positioned to navigate current market trends and generate strong returns for investors over time.
- Public Storage (PSA) is one of the largest owners and operators of self-storage facilities in the United States, with more than 2,300 facilities across the country. As a REIT, PSA has a strong track record of generating stable earnings and distributing income to investors through regular dividends.
Investment funds
One of the easiest ways to invest in REITs is through investment funds that specialize in real estate investments. These funds can be a good option for investors looking to gain direct exposure to the asset class without having to select individual companies, and many offer diversified portfolios across regions, sectors and market capitalization levels.
Ultimately, whether you want to invest directly in REITs or want to create a diversified portfolio that includes exposure to this asset class through mutual funds or ETFs, there are many opportunities available to help you achieve your financial goals. Working with an experienced financial advisor can help you develop an investment plan tailored to your needs and risk tolerance.
Investing in REITs – Questions and Answers
What are the advantages of investing in REITs?
- Tax benefits: since REITs do not pay taxes on their profits if they distribute all the income to investors, these companies can typically offer higher returns than traditional stocks or bonds.
- Diversification: one single REIT may hold up to hundreds or thousands of different properties, in different geographies and used for different purposes. This obviously creates a massive advantage in terms of risk diversification compared to a direct investment in one or few physical properties. Moreover, REITs have historically presented limited price swings compared to stocks or bonds.
- Periodic Income: REITs offer a stable source of income through quarterly dividend payments, which makes them particularly attractive to investors looking for a steady income stream. In addition,
- Reliability: REITs are audited by independent accounting firms and their activities are highly supervised by the relevant financial authorities.
What are the disadvantages of investing in REITs?
Like any investment, REITs carry some risk. The main risk is that the value of a REIT’s real estate assets may decline due to factors such as economic downturn or changes in local real estate demand. Performance can be affected by fluctuations in the housing market, which means that REIT stock prices can rise or fall significantly based on the dynamics of the housing market.
REITs are also subject to operational risks, such as the availability of reliable tenants or property maintenance expenses.
In addition, because REITs are required to distribute at least 90% of their income to investors each year, they must rely on external financing for growth opportunities and may be more vulnerable to credit market fluctuations.
One of the most important risks that REITs face is interest rate risk: rising interest rates increase borrowing costs, which in turn impact the company’s cash flow, credit profile and profitability.
What to evaluate before investing in REITs?
Before investing in a REIT, it is important to consider a few aspects.
For example, don’t be fooled by dividends that are too high, which could be the result of poor company management or cash flow. In addition, it is important to consider dividend coverage, which is the extent the company can pay dividends out of its after-tax profits.
Many REITs might cover their dividends very well with FFO (Funds From Operations), but poorly with AFFO (Adjusted Funds From Operations), which takes into account maintenance costs and capital expenditures, thus more accurately estimating the current values of the REIT and the ability to pay dividends.
Another aspect to consider is the WALE (Weighted Average Lease Expiry), which measures the average expiration time of leases of a REIT’s real estate. A longer WALE can be a guarantee for investors in a period of economic crisis, as renters are bound to their leases for a longer period.
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Photo by Frames For Your Heart on Unsplash
Photo by Sean Pollock on Unsplash
