Real estate investment trusts (REITs) are companies that own and manage income-generating commercial real estate. They either own the properties or finance and manage the mortgages on the properties. REITs generate income by leasing space and collecting rent on their real estate. Also, they produce income from interests on real estate mortgages. The income generated by the REIT is distributed among its shareholders in the form of dividends.
Individuals can invest in various real estate portfolios by investing in particular companies, mutual funds, or an exchange traded fund (ETF). Investing in REIT can provide a good counterbalance to your stocks, bonds, and cash.
Read more: What is Real Estate Investment Trust (REIT)?
Historical Returns of REIT
In the past 45 years, REITs have proven to be a reliable investment (12%) with increasing dividends and a dependable long-term capital appreciation. Compared to stocks (11%) and bonds (7.3%), REITS have given its investors attractive prospects, historically. In the past 20 years, REITs returned a 10.66% on average annual dividend payout, 4% more than small-cap and large-cap stocks on the same years.
There are (at least) 5 types of REITs you may choose from depending on your interests and inclinations, or the recommendation you get from your broker or financial advisor. The 5 types of REITs are: retail, residential, health care, office, and mortgage. Let's take a look at them.
Retail REIT
Retail REITs rents out store space to tenants in malls, shopping centers, and factory outlets. This is their income production model. They depend on the tenants' capacity to pay rent, and may face difficulties when tenants experience cash flow problems or bankruptcy due to low sales.
So if you decide to invest in retail REIT, you need to study what the retail industry is going through and where it is headed. Is there an upward trend or an increase in retail stores or outlets? Or is the industry facing too strong a challenge from online shopping? Also, it will be good to consider retail REITs with anchor tenants, or tenants with anchor products such as groceries and home improvements, which are almost always on demand.
Residential REIT
Residential REITs is as its name indicates – a residential related REIT. Residential REITs own and operate residences, apartment buildings, and housing projects. They generate income through rent, much the same way that retail REITs do. But in the case of residential REITs the focus is on family, workers, students, or permanent residents.
So in case you're thinking of investing in residential REIT, look for neighbourhoods where buying houses are quite unaffordable and people (families) would tend to rent apartment spaces. Look for places that show economic growth in terms of increased population and new job generation. These are places where a lot of people (workers) will more likely be looking for places to rent. Also, places accessible to universities and colleges where there is a constant influx of students are more likely to generate more rental income.
Healthcare REIT
Healthcare REITs focusses on real estate connected to hospitals, healthcare facilities, nursing homes, and retirement homes. They are tied directly to the healthcare industry. Their income is derived from the rental of tenants to these facilities, which come mainly from occupancies, Medicare reimbursements, and private pay.
With a constantly ageing population, you must be in the lookout for healthcare institutions with a consistent positive track record, a good balance sheet, and have low-capital assets. Also, look for healthcare REITs with investments in diversified healthcare real estate.
Office REIT
Office REITs own and operate office real estate. These could be in the form of suburban park spaces or tall skyscrapers in central business districts. Office REITs collects rent from tenants who are usually on long-term lease agreements for office spaces. Office spaces could vary from government-run offices to privately-owned biotech corporations.
When investing in Office REITs, you should be aware of how the area of your selection, where the office real estate is, is doing economically. This will give you an idea if office space rentals is a thriving business in the area. Also, you need to know how high the vacancy rate of the office REITs real estate has been. The above parameters should be a deciding factor for you.
Mortgage REIT
Mortgage REITs (mREITs) does not directly deal with real estate, but with the mortgage of real estate. mREITs typically acquire the mortgages of homeowners and businesses using private (equity and debt) capital to fund loans. Also, they purchase commercial mortgages and commercial mortgage-backed securities (CMBS) to provide liquidity to businesses in commercial real estate. They derive income from their net interest margin, i.e., interest income on mortgages less funding costs.
You should keep an eye on interest rates if you are interested in mREITs. Interest rates have an inverse effect on the value of mREIT portfolios -- high interest rates equals lower portfolio value; lower interest rates equals higher portfolio value.
Key Assessment Factors of Any REIT
Here are 5 factors to consider in assessing REITs before you decide to invest in one:
1. The company. Look for a REIT company that has a good, profitable track record. REITs are profitable investments if you invest in the right company. They are total-return investments and give excellent dividends. Also, you should expect capital appreciation in the long-term.
2. Liquidity. REITs allow you to invest in real estate without your money getting locked up on real estate. Investing in REITs is just like investing in any other stock – they are also traded on the stock exchange.
3. Funds from operation (FFO). This gives you an indication (benchmark) of a REIT's cash flow from operations. It is NOT the cash flow. FFO is Net Income plus depreciation plus amortization LESS gains on sales of property. You can examine the FFO of a REIT since they are publicly posted in their annual financial statements.
4. Strong management. Look for experienced managers, those who have been around for a long time in the REIT industry.
5. Give careful thought on the economy and business side of the equation – where is the real estate located, who are its tenants, what is their business, and is the economy growing?
These are questions you need to ask, and the factors you need to consider to help you decide to invest in a particular REIT.
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(Written by G. Zizan, 14 November 2019)
