This may be a great time to get into a REIT. If you’re trying to
sell commercial or residential real estate today, you face quite a
challenge. On the other hand, buyers are seeing all kinds of
opportunities to pick up properties at depressed prices.
This may be a great time to get into a REIT. If you’re trying to sell commercial or residential real estate today, you face quite a challenge. On the other hand, buyers are seeing all kinds of opportunities to pick up properties at depressed prices.
You may want to seize these opportunities, but you may not want to manage property. Is there a way you can invest in real estate without turning into a landlord?
There is. REITs (Real Estate Investment Trusts) allow you to get into the commercial real estate sector without the hassles of property management.
You may assume that REITs have taken a pounding recently. You would be wrong. REITs have outperformed stocks in the last couple of years. The total return for the FTSE NAREIT All-Equity REIT Index was +27.95 percent last year. The total return of the FTSE NAREIT All-REITs Index was +27.58 percent. Compare that to a total return of +15.05 percent for the S&P 500.
With reduced real estate valuations and stricter credit terms, the present commercial real estate market has many distressed owners and properties, so now may be a prime time to get into a REIT in pursuit of dividends and long-term appreciation.
According to data from Real Capital quoted by Bloomberg, the average capitalization rate on commercial properties (excluding hotels) was 7.2 percent as of the fourth quarter of 2010. Stack that up against the yield from a CD, a corporate bond or a 10-year Treasury.
What do you own when you invest in a REIT? An equity REIT offers investors an opportunity for fractional ownership of a real estate portfolio.
The portfolio commonly includes high-quality commercial properties – shopping malls, apartment buildings, office complexes and sometimes even things like golf courses or resorts.
Some REITs have little to no investment minimums, so they allow the small investor an easy entry into the “major leagues” of commercial real estate.
While investors own common shares in the REIT, there is a wrinkle that distinguishes a REIT from a corporation. A REIT has to pay out 90 percent of its operating profits as dividends. This exempts a REIT from having to pay corporate income tax.
What’s the potential downside? There is basically an inverse relationship between REIT share prices and interest rates. When interest rates spike, REIT shares can dramatically lose value. (Of course, the resulting selloffs may present REIT investors with buying opportunities.)
The regular dividend payments a REIT makes can also become a hindrance. When you’re routing at least 90 percent of your taxable profit back to the shareholders, you’ve got less than 10 percent of it to reinvest. For this simple reason, most REITs grow slowly.
Also understand that shares in non-traded REITs are generally considered illiquid until the REITs exit strategy either returns investors principal or lists on a public exchange. No public market exists for shares of common stock of a non-traded REIT.
Even if investors can sell their shares through a secondary market, it is likely that they will have to sell them as significant discount from the public offering price.
The REIT may not achieve it desired diversification or investment objectives or be able to pay dividends.
The shares, when redeemed, may be worth more of less than the offering price. If the value of the assets in which the fund invests decline, investors share may lose value.
The REIT could be vulnerable to economic and geopolitical conditions. For example, a REIT that that invests in the office sector may be negatively affected by an economic down that leads to tenant default of vacancies.
A look at the REIT varieties. There are three different classes of REITs.
– Equity REITs invest in hard assets (real property). The vast majority of REITs are equity REITs and most of them specialize in an income property type. There are apartment REITs, retail REITs, industrial REITs and so forth.
– Mortgage REITs do not invest in hard assets. Instead, they take out short-term loans to buy mortgage-linked securities. Their profits stem from the difference between the long-term interest rates of the bonds and the short-term interest rates paid on the loans.
– Hybrid REITs invest in commercial properties and mortgage-linked securities.
In addition, there are traded and non-traded REITs.
– Public REITs trade on an exchange, and therefore offer more liquidity to an investor. The downside, naturally, is that they also expose an investor to market volatility.
– Private REITs are not (yet) publicly traded and reduce the degree of volatility for the investor. Liquidity can be an issue as you have to sell shares through the REIT company, unless another investor in the REIT steps up to buy them.
The dividend income from a REIT may produce a bond-like yield and can potentially amount to a very nice income stream.
REITs offer another way to diversify. If you own a bunch of stocks and funds, they give you a chance to broaden your portfolio. If you own real property already, they still offer you a nice avenue for diversification.
If you are a sole owner of an income property, you are positioned to receive 100 percent (or nearly 100 percent) of the profits when you sell it.
However, you must shoulder the burden of property management yourself or screen for a competent, attentive third-party manager, and you are also poised to personally absorb any loss or unforeseen costs. Sole ownership includes sizable risks.
In contrast, an equity REIT might own dozens, hundreds or even thousands of income properties – and all of them are professionally managed, often by a single firm owned by the REIT.
So investing in real estate through the REIT gives you a quality of diversification you couldn’t possibly attain as a small investor, a quality of property management that the small investor seldom sees, and the leadership of veteran commercial real estate investors making the buy and sell decisions. And you have the potential for a nice dividend.
