Real Estate Investment Trusts

A REIT (Real Estate Investment Trust) is a corporation, trust or association that owns and manages a portfolio of real estate properties and/or mortgages, allowing shareholders to invest in larger-scale, income producing real estate through a traditional method: The stock market. REITs combine the potential of real estate's increasing value over time with the benefits of transparency and liquidity associated with publicly traded stock.

Potential benefits of REITs

  • By law, REITs must pay out at least 90% of taxable income as dividends. Since REITs can deduct dividend payouts, they avoid most (if not all) tax liability, leaving more earnings for investors.
  • REITs must have at least 100 shareholders after its first year as a REIT, and since no more than 50% of the total shares of the trust can be held by any five investors in the last half of its taxable year, it opens up the field to a wide range of shareholders.

Different types of REITs

Most REITs are traded on major stock exchanges, just like other types of stocks. And, like real estate itself, they provide investors with the ability to diversify their portfolio with a vehicle that seeks to provide current returns as well as long-term growth potential, as real estate income historically has kept pace with inflation.*

  • Equity REITs. The majority of REITs are equity REITs, which own and operate real estate ventures directly. Its revenues are derived from the lease or rent payments of tenants, which are then distributed to shareholders as dividends. If a REIT liquidates property holdings, capital appreciation is also distributed to shareholders as dividends.
  • Mortgage REITs.mortgage REIT is involved in the financing aspect of real estate. It may invest in and own residential mortgages, commercial mortgages, residential mortgage-backed securities (RBMS), and commercial mortgage-backed securities (CMBS).
  • Hybrid REITs. A hybrid REIT owns and operates properties and invests in mortgages and/or mortgage-backed securities.
  • Traded vs. Non-Traded. Most REITs are traded publicly, and are more liquid than non-traded REITs, with lower up-front fees.

REITs come with risks

While REITs enable investors to diversify their portfolios with a product that seeks to provide a good return and grow in value over the long term, as with any other type of investment, there are potential risks to consider.

  • Declining value properties. When choosing a REIT, be mindful of the growth prospects of the industries, property types or geographical locations they are targeting.
  • Fees. What “wrapper" are your investments in and what are the associated costs? For instance, non-traded REITs generally have significantly higher upfront fees than publicly-traded REITs, and may have early withdrawal penalties. Non-traded REITs may also have highly-paid external management fees that diminish dividends.
  • Interest rates. Rising rates can be a double-edged sword when it comes to investing in REITs. If higher rates are driven by growth in the underlying economy, inflation is passed through in the form of higher rents which is growth in income to the investor. Conversely, if interest rates rise without economic growth (i.e. stagflation) other classes of real assets may face diminished returns.
  • Lack of information. Those investing in non-traded REITs may not be able to access data about the REIT's assets, value, management team and overall performance prior to investing.

Myths

Myth #1: You have to be rich to invest in real estate funds.
Truth: Buying property often comes with a sizable monetary investment. Investing in REITs, however, can be done by nearly any investor, regardless of portfolio size because of their availability in investments such as mutual funds and exchange traded funds.

 


Myth #2: REIT is the same as investing in real estate.
Truth: REIT shareholders do not own the property or mortgages represented in its portfolio. As such, they also avoid the headaches many property owners and managers experience, such as maintaining or developing the property, providing landlord services, collecting rent payments to name a few.

 


Myth #3: An increase in interest rates will automatically hurt REIT dividends.
Truth: Historically, some REITs have experienced diminished performance in the face of higher interest rates. However, many REITs outperformed other investments, even in the face of high interest rates. Furthermore, REITs often outperform other stocks in a slow economy.

Investment considerations

REITs represent a good choice as a stand-alone or starter investment or as an investment to complement or diversity a portfolio. When choosing a REIT, here are some things to consider.

  • Past performance. How well has the REIT performed most recently and over time? If it's performed well, have there been any recent changes to the management team that might change its performance in the future?
  • Composition. Does the REIT represent industries or geographical areas which are growing or which are likely to decline in coming years?
  • Transparency. How much information is available about the REIT's past performance, composition, management team and fees?
  • Timing. What is your investment timeline? Are you most interested in an investment with the potential to gain rapidly over the short-term or one that is more stable, and whose growth potential is likely to occur over time?

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted.