Let’s delve into the basics of a real estate investment trust or REIT, to see how it works to achieve long-term returns for investors.
The real estate sector is a thriving one that’s filled to the brim with avid investors looking to make some significant gains from a timeless space. However, the conventional process of acquiring and managing properties can be greatly arduous – like most things worth having.
This, among other reasons, has given way to some interesting innovations in real estate investment. Real estate investment trusts (REITs) have gained popularity over the years as a more convenient and arguably more versatile entry point into real estate, topped with the prospect of maximising gains.
What is a REIT?
A fund or trust known as a real estate investment trust (REIT) owns and oversees commercial real estate that generates revenue (shopping complexes, hospitals, plantations, industrial properties, hotels and office blocks).
A REIT’s management business is allowed to deduct shareholder distributions from its corporate taxable income. However, in order for the REIT to benefit from this tax-free status, the majority of its assets and income must be related to real estate, and it must yearly distribute at least 90% of its total income to investors and unit holders.
REITs, which function similarly to mutual funds, were created in 1960 to enable smaller investors to buy a part in substantial real estate assets.
The most important criteria for us investors is that a company must return at least 90% of its taxable revenue to shareholders in the form of dividends in order to qualify as a REIT. Other requirements include receiving at least 75% of its income from real estate operations. The secret to these uncommon securities is that they make great dividend plays.
Who can invest in a REIT?
When investors wish to increase their portfolio’s yield, they frequently use real estate investment trusts (REITs), which are stocks. These investment options provide a simple method to hold a stake in real estate that generates income.
Although REITs have the potential for large returns, they are riskier than lower yielding alternatives like Treasury bonds, like other assets with high returns.
How does REIT work?
The most popular way to invest in a REIT is through your broker, just as you would with a stock. There are a variety of non-publicly listed REITs that can be accessed through retirement plans or particular brokers. Most REITs are publicly traded companies that allow for regular investment. Retail investors can also purchase REIT ETFs and mutual funds.
Investors need to be aware of a few subtleties while performing due diligence on a REIT. In contrast to traditional equities, funds from operations (FFO) is used to quantify cash flow rather than earnings per share (EPS).
Gains on sales are subtracted from earnings while depreciation and amortisation are added to identify FFO (Funds from operations referring to the figure used that defines the cash flow from REIT operations). This is an illustration of how, despite the fact that REITs behave and speak like stocks, they are distinct entities that should not be invested in without careful thought and due diligence.
What are the benefits of investing in listed REITs?
Direct real estate investment is more expensive than investing in REITs. You only need a reasonably small initial investment which is cost effective in comparison to a few other alternative options or asset classes.
When compared to real properties, REITs are more liquid. Since publicly traded REIT shares are traded on the stock market, they can easily be converted to cash. Unlike traditional real estate, which is one of the least liquid assets, REITs behave like shares, giving investors a great deal of freedom in how they buy and sell them.
3. Stable income stream
The dividend that REITs typically provide is obtained from the ongoing rentals that tenants who inhabit the REIT assets pay.
4. Exposure to a large-scale real estate
Through a REIT, the advantages of the real estate are obtained pro rata.
5. Professional management
Since REIT properties are managed by experts, investors will gain in the long run since they will add value for a greater yield.
They represent a diversification strategy. A REIT is traded like a stock, but you shouldn’t handle it that way. No matter how much or how little you invest, it’s your own money in a REIT. It is a low-cost method of portfolio diversification that stays away from bonds and stocks.
7. Managed by experts
When you invest in REITs, your money will be totally managed by experts, allowing you to relax and reap the rewards.
Say good-bye to problematic renters, mortgage loans, house hunting, and the rest because REIT management teams oversee the tenants and the maintenance of the buildings, unlike investing in physical properties.
8. High reward
The dividends received by investors are between 5% and 7%, with payouts made every three months or twice a year, depending on the REIT fund manager, because REIT distributes at least 90% of its earnings to unitholders. This is significantly higher than the return on most rental properties, which is typically only between 3% and 5%.
Since real estate rentals are the primary source of dividend yields for REITs, their returns are also far less volatile than those of other markets. Dividend rates will therefore stay constant as long as the properties you invest in have renters. Do your research before investing in a REIT, but keep in mind that, unlike fixed deposits, they do carry their own risks and that returns are not guaranteed.
What are the risks involved with REITs?
Because REITs are listed on the stock market, they have more risks than equity investments. In response to external stimuli, underlying fundamentals, and a number of other market dynamics, real estate prices rise and decrease. REITs will, in turn, reflect any slack and mimic how it affects prices.
Although REITs can have significant long-term returns, there have been times when they haven’t. For instance, the price of shares in the iShares Dow Jones U.S. Real Estate ETF (IYR) fell around 77% from a peak of $91.42 to a low of $20.98 when the real estate bubble burst between early 2007 and early 2009.3
To invest or not to invest?
REITs provide a variety of special benefits, but they also have hazards just like any other asset type. If you invest in a REIT, your returns are not always assured.
They are susceptible to the ups and downs of the real estate market, a notoriously volatile industry, and because 90% of their profits must be distributed as dividends, they are occasionally prone to relatively slow development.
They continue to be a very alluring asset class, nevertheless, and should be included in any solid, diversified portfolio.
Ultimately, if you’re interested in infiltrating the real estate market in pursuit of high yield, and you’re aware of the potential risks involved in such an endeavour, then REITs may be a good opportunity for you as an investor. REITs have a proven track record of offering a high level of current income together with long-term share price appreciation, inflation protection, and effective diversification.
As always, it’s important to consider your options and conduct due diligence before venturing into anything new.