What Are Real Estate Investment Trusts (REITS)?
A Real Estate Investment Trust is a fund or a pool of money that invests in commercial-type real estate investments either by purchasing them or by funding the investments directly. They give everyday people access to commercial real estate who would not normally have access to investing in commercial real estate.
There are generally two types of Real Estate Investment Trusts (REITs).
There is the equity REIT and there is the mortgage REIT. The equity REIT obviously invests in equity or properties and mortgage REITs invest in funding or mortgages for the properties.
In general, REITs are an alternative to investing in the stock market. So investing in REITs helps you provide some diversification within your investment portfolio. REITs also provide diversification within the fund because the fund may invest in various classes of REITs creating a hybrid type of REIT. It may invest in equities and some mortgages and different classes of equities.
What Are the Ways to Invest in REITs?
There are three different ways to invest in REITs.
- Publicly Traded and listed. You can buy these on a stock exchange such as the New York stock exchange or other stock exchange. The advantage of this type is that they are more liquid because you buy and sell them right there on the exchange. The disadvantage is they usually have lower returns and they’re also impacted by any fluctuations in the overall investment market usually because of changes in interest rates
- Publicly Traded, Non-Listed. These are REITs that are not listed on the stock exchange but are publicly available. You can purchase these through your financial advisor.
- Private REITs. These usually aren’t available to the individual investor. They are only available to the institutional type of investors, for example, private equity firms.
What Are The Classes Of REITs?
There are also different classes of REITs.
- Office REITs: These are REITs that invest in obviously office buildings, office towers.
- Industrial REITs: These invest in industrial properties, warehouses and industrial land.
- Retail REITs: These invest in malls or shopping centers.
- Hospitality REITs: These invest in hotels and motels.
- Residential REITs: These invest in multifamily, apartment buildings and garden home complexes.
And there’s a scattering of other types of REITs. And there are REITs that invest in a hybrid of the different types or the different classes that I just listed.
What Are the Advantages of REITs?
The advantage of REITs over investing directly in real estate is that they are very passive. You don’t have any tenants to manage. There are no contractors to manage if doing a fixed and flip and no properties to find if you’re doing wholesaling. And REITs are run by an experienced management team, so you don’t have to worry about making mistakes yourself. Those activities of acquiring properties and managing those properties are done by the management team.
So, the investor of a REIT owns shares in it, just like when you’re buying shares in a company. You do not own the underlying properties or the underlying real estate directly. Not like you do in private equity or when you’re buying real estate directly.
REITs are very low risk, but because they are such low risk, they give low returns. REITs will give you low returns, maybe a medium return might be a better way of saying it. So somewhere in the neighbourhood of 4% or 5%.
REITs pay dividends. And these dividends are based on the profits you get from your rent profits or as well as capital gains from the sale of a property and from principal pay down.
What Are the Disadvantages of REITs?
The challenge with REITs is that there are a lot of rules and regulations associated with them. Also, the dividends may be non-qualified. This means you may have a larger or a higher tax obligation.
Another thing with REITs is that they have to pay out a certain percentage of the earnings to their shareholders. And that’s usually 90%. The problem with that is they don’t retain any capital for growth. And that’s why the returns are fairly low.
There are also high fees associated with operating REITs. These are usually in the neighbourhood of 10% to 15%. So, because of these high fees, there is no incentive for the REIT to perform better.
The other thing is a REIT may be under pressure because they have all this money coming in and they need to buy before they’ve done their complete due diligence. They have all this excess cash that they have to deploy.
REITs are an alternative for non-accredited investors as well because of the low entry point versus private equity firms’ investments.
So those are some of the advantages, disadvantages of REITs and why you should invest in REITs If it makes sense for you.
