What is a Real Estate Investment Trust (REIT)?
A real estate investment trust (REIT) is a corporation that owns, operates or finances income-generating real estate. Similar to mutual funds, REITs pool the capital of many investors. This allows individual investors to earn dividends on their real estate investments, without having to buy, manage or finance properties themselves.
Key points to remember
- A real estate investment trust (REIT) is a company that owns, operates or finances income-generating properties.
- REITs generate a steady stream of income for investors, but offer little capital appreciation.
- Most REITs are traded like stocks, making them very liquid (unlike physical real estate investments).
- REITs invest in most types of real estate, including apartment buildings, cell phone towers, data centers, hotels, medical facilities, offices, shopping malls, and warehouses.
How REITs Work
Congress created the REITs in 1960 as an amendment to the extension of the excise tax on cigars. The provision allows investors to buy shares in commercial real estate portfolios, which was previously only available to high net worth individuals and through large financial intermediaries.se.se.sssssssse.se.sssssss
The properties of a REIT portfolio can include apartment complexes, data centers, healthcare facilities, hotels, infrastructure – in the form of fiber optic cables, cell phone towers, and energy pipelines – office buildings, retail centers, self-service warehouses, woodlots and warehouses.
In general, REITs specialize in a specific real estate industry. However, diversified and specialized REITs may hold different types of properties in their portfolios, such as a REIT consisting of both office and retail properties.
Many REITs are listed on major stock exchanges, and investors can buy and sell them like stocks throughout the trading session.se.se.sssssssThese REITs generally trade in substantial volume and are considered very liquid instruments.
Real Estate Investment Trust (REIT)
What qualifies as a REIT?
Most REITs have a simple business model: the REIT rents premises and collects rents from properties, then distributes that income as dividends to shareholders. Mortgage REITs do not own real estate, but rather finance real estate. These REITs earn interest income on their investments.
To qualify as a REIT, a business must comply with certain provisions of the Internal Revenue Code (IRC). These requirements include primarily owning long-term income-generating real estate and distributing income to shareholders. More specifically, a business must meet the following requirements to qualify as a REIT:
- Invest at least 75% of total assets in real estate, cash or US Treasury bills
- Get at least 75% of your gross income from rents, interest on mortgages that finance real estate or real estate sales
- Pay a minimum of 90% of taxable income as dividends to shareholders each year
- Be a taxable entity as a corporation
- Be managed by a board of directors or trustees
- Have at least 100 shareholders after its first year of existence
- Not have more than 50% of its shares held by five people or lessse.se.sssssssse.se.sssssss
Today, it is estimated that REITs collectively own approximately $ 3 trillion in gross assets; Publicly traded equity REITs are worth $ 2 trillion.se.se.sssssssse.se.sssssss
Types of REIT
There are three types of REIT:
- REIT stocks. Most REITs are equity REITs, which own and manage income producing real estate. Income is generated mainly by rents (and not by the resale of buildings).
- Mortgage REITs. Mortgage REITs lend money to property owners and operators either directly through mortgages and loans, or indirectly through the acquisition of mortgage-backed securities. Their income is mainly generated by the net interest margin, which is the difference between the interest they earn on mortgages and the cost of financing those loans. This model makes them potentially sensitive to interest rate hikes.
- Hybrid REITs. These REITs use the investment strategies of equity and mortgage REITs.se.se.sssssssse.se.sssssss
Type of REIT
Owns and operates income producing real estate
Holds mortgages on real estate
Owns properties and holds mortgages
REITs can be classified based on how their shares are bought and held:
- Listed REITs. Shares of publicly traded REITs are listed on a national stock exchange, where they are bought and sold by individual investors. They are regulated by the United States Securities and Exchange Commission (SEC).
- Public non-traded REITs. These REITs are also registered with the SEC but do not trade on national stock exchanges. As a result, they are less liquid than publicly traded REITs. Still, they tend to be more stable because they are not subject to market fluctuations.
- Private REITs. These REITs are not registered with the SEC and do not trade on national stock exchanges. In general, private REITs can only be sold to institutional investors.se.se.sssssssse.se.sssssss
How to invest in REITs
You can invest in publicly traded REITs, as well as REIT mutual funds and REIT exchange traded funds (ETFs), by purchasing stocks through a broker. You can buy shares of an unlisted REIT through a broker or financial advisor who participates in the unlisted REIT’s offering.
REITs are also included in a growing number of defined benefit and defined contribution investment plans. An estimated 87 million U.S. investors own REITs through their retirement savings and other investment funds, according to Nareit, a Washington, DC-based REIT research firm.se.se.sssssssse.se.sssssss
REIT activities resulted in the distribution of $ 69 billion in dividend income in 2019 (most recent data available).se.se.sssssssse.se.sssssss
There are over 225 publicly traded REITs in the United States, which means you will have some homework to do before deciding which REIT to buy.se.se.sssssssMake sure you consider the REIT’s management team and track record and find out how they are compensated. If it’s performance-based pay, there’s a good chance they’re working hard to pick the right investments and the best strategies.
Of course, it’s also a good idea to look at the numbers, such as the expected growth in earnings per share and current dividend yields. One particularly useful metric is the REIT’s funds from operations (FFO), which is calculated by adding depreciation and amortization to earnings, and then subtracting gains on sales.
Pros and Cons of Investing in REITs
REITs can play an important role in an investment portfolio as they can offer a strong and stable annual dividend and the potential for long-term capital appreciation. The total return of REITs over the past 20 years has outperformed the S&P 500 Index, other indices and the rate of inflation.se.se.sssssssAs with all investments, REITs have their pros and cons.
On the plus side, REITs are easy to buy and sell, as most trade on public exchanges, a feature that alleviates some of the traditional real estate drawbacks. From a performance perspective, REITs offer attractive risk-adjusted returns and stable cash flows. Additionally, a real estate presence can be beneficial for a portfolio as it provides diversification and dividend-based income, and the dividends are often higher than what you can get with other investments.
In contrast, REITs don’t offer much in terms of capital appreciation. As part of their structure, they must pay 90% of the income to investors.se.se.sssssssThus, only 10% of taxable income can be reinvested in the REIT to purchase new equity interests. Other negatives are that REIT dividends are taxed as regular income and some REITs have high management and transaction fees.
The Securities and Exchange Commission (SEC) recommends that investors beware of anyone attempting to sell REITs that are not registered with the SEC. It states that “You can verify the registration of listed and unlisted REITs through the SEC’s EDGAR system. You can also use EDGAR to review a REIT’s annual and quarterly reports as well as any offering prospectuses.”se.se.sssssssse.se.sssssss
It is also a good idea to consult with the broker or investment advisor who recommends the REIT. The SEC has a free search tool that allows you to check if an investment professional is licensed and registered.
Real example of a REIT
Another consideration when choosing REITs is to look at which areas of the real estate market are hot. What booming sectors of the economy, in general, can be exploited through real estate? As an example, healthcare is one of the fastest growing industries in the United States, particularly in the growth of medical buildings, ambulatory care centers, senior care facilities, and communities. of retirement.
Several REITs focus on this sector. Healthpeak Properties, formerly HCP, is one example. As of July 22, 2020, it had a market capitalization of nearly US $ 14.4 billion, with some 5 million shares traded daily.se.se.sssssssIts portfolio focuses on three core asset classes: life science facilities, medical practices and senior housing.se.se.sssssssse.se.sssssss