According to the SEC, a Real Estate Investment Trust (REIT) is “a company that owns – and typically operates – income-producing real estate or real estate-related assets.”
Most experts liken REITs to mutual funds and they have a point to do so since there are many similarities. On the whole, this is an investment in property.
What Is A Real Estate Investment Trust (REIT)
History And Recent Developments
Back in the 1960s, the REITs were established by Congress and have existed ever since. The mission of these companies was to be accessible and affordable to anyone. They provide investors with a stable income and a long-term increase in the value of assets.
Although they have been around for more than 6 decades, REITs have become a hot trend in the last decade. This is primarily due to low-interest rates, which forces investors to look for alternative investment options. In addition, the outbreak of the financial crisis in 2008 increased people’s desire to have real estate assets.
Another key moment in the history of REITs is August 31, 2016. On this day S&P and Dow Jones transferred equity REITs from the Financials Sector of the Global Classification Standard to a new one – Real Estate Sector. This sector is the first new one since 1999, reflecting the importance of real estate. Despite this, mortgage REITs are still listed in the Financials Sector.
How They Work
In addition to offering long-term capital appreciation and regular income in the form of dividends, these corporations are affordable. Instead of purchasing the real estate yourself, you buy stocks in a REIT and get all the benefits stemming from it.
But be aware:
Most REITS are publicly traded on stock exchanges, but there are some that are private.
It’s important to clarify that Real Estate Funds and Real Estate Investment Trusts are not the same things. The former is a type of mutual fund, which invests in securities. The latter is a company that owns or operates income-generating properties.
To sum up:
Mainly, there are two types of REITs – equity and mortgage REITs. Keep in mind that the SEC identifies three types, therefore we will stick to their classification. Below you will find more details and examples of the three types.
Types of REIT
1. Equity REITs
It’s safe to say that most REITs are equity ones – they own commercial buildings, retail stores, residential buildings, shopping centers, and all types of large-scale real estate.
How do they operate
Most of their revenues come from renting the properties they own. For example, a REIT owns a large, multi-story office building and rents it to a high-profile tenant. As a rule, these trusts are the safest of the three types.
2. Mortgage REITs
Instead of owning real estate, mortgage REITs lend money to real estate owners, just like banks do. These companies can also acquire mortgage-backed securities.
Of course, this types is much more leveraged because they use borrowed money to invest. They profit primarily from the interest on their investments. These trusts are riskier than the others because there is always a possibility of fluctuations in interest rates.
3. Hybrid REITs
As the name suggests, these companies combine elements from both equity and mortgage REITs. An example of hybrid REITs is W.P. Carey Inc. Their portfolio consists of 900 properties totaling $8.5 billion. In addition, they provide financing to other real estate companies or builders.
There are five main sectors in which REITs invest:
- Office REITs – these are equity REITs specialized in renting commercial office buildings.
- Residential REITs – these companies own and manage residential properties.
- Retail REITs – these are equity REITs, which rent retail real estate, for example, malls.
- Industrial REITs – the name gives us a clue and it refers to companies that rent industrial spaces.
- Lodging REITs – these are equity REITs that specialize in managing hotels or different types of accommodation.
All REITs, regardless of their type, must comply with several strict rules and requirements:
- After the first year, all REITs must have at least 100 shareholders
- The trust should be managed by a board or trustees
- At least 90% of the taxable income should be paid out in the form of dividends
- Five or fewer shareholders cannot possess more than 50% of the shares
- Minimum 75% of all assets should be invested in real estate and property, cash or US Treasury
- Minimum 75% of the gross income should come from real estate
- Payout ratios should be at least 90%
- Maximum 25% should be invested in non-qualifying securities.
As you can see, there is plenty of rules and regulations companies must abide by. Some REITs register with the SEC and can trade publicly their shares on stock exchanges. Others prefer to remain private companies – they do not register with the SEC.
Many people prefer putting their money into REITs due to the high dividend payout ratio with dividends ranging between 5-8%. Most REITs use these dividends for tax reduction.
Bear in mind:
Investors are not exempt from paying taxes on their income. Just like their counterparts, mutual funds, REITs offer their shareholders different dividend reinvestment plans. This can lead to a long-term increase in the initial investment.
Benefits Of REITs
To start with, REITs offer simplicity. Investors enjoy all the benefits without buying the property themselves and renting it afterward with all the troubles that come along with it.
Just like mutual funds, these corporations are managed by professionals who know how, when and what to do. All investors get is the income coming from the possession of shares.
REIT shares are very liquid, which means that an investor can easily sell and buy them. In addition to that, compared to equity stocks, REIT shares are less volatile. This is due to the nature of investment – real estate. They tend to be much more predictable in the long-run. While equity stocks are quite volatile and unpredictable, property expenses are quite consistent.
As you know, REITs pay their shareholders primarily in the form of dividends, which is a stable income. What’s more, in the long-run, most REITs perform better than some of the major indices. Dow Jones, Nasdaq and S&P 500.
Another great advantage is the fact that investors have the chance to build a diversified portfolio. Through diversification, they can increase their returns in the long run. Also, the price of their assets is not strongly correlated to the price of say bonds and stocks, which also helps the diversification of a portfolio.
Investing in real estate is perhaps one of the safest options one can opt for. However, most people cannot afford to purchase properties in which to invest because they are expensive. There is always a solution to each problem.
While you can try real estate crowdfunding for example, but many people want to have a slice of the cake by their own. That’s understandable. REITs offer their investors to benefit from real estate assets without having to buy it or own it.
They simply have shares, which bring them stable income in the form of dividends – both cash and stock dividends. What’s more, someone else takes care of “your” property. This is a relatively risk-free way to dive into the world of investing.