REITs. Real Estate
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Like a common stock you can buy shares of a real estate trust. You make money from the appreciation of the shares and dividends.
A REIT is different from a public company in several ways. These real estate trusts must pay 90% of their income to shareholders. By doing so, these dividends are deducted from corporate income tax. To maintain REIT status, 75% of the assets must be invested in real estate, mortgage loans or shares of other trusts.
This industry has plenty of expansion room. The commercial real estate market is worth over $4 trillion. REITs mange about 10% of it.
The commercial real estate market is cyclical. Locations can experience cycles of depression, recovery, boom and downturn. These cycles can vary in length and different parts of the country can experience different phases.
A trust's performance does not correlate with the stock market. While stocks may be tanking from news about oil & the economy, real estate trusts continue to collect rents. REITs provide income, appreciation and a hedge against inflation. Advisers recommend between 5%-12% invested in these funds.
• What is the dividend yield? The main benefit of a REIT is income. You might as well compare it to other REITs and their past history.
• What is the market like for the properties owned? If a real estate trust owns strip malls in the southeast, are they having trouble filling vacancies? Is unemployment high?
REITs have different investment philosophies. A real estate trust that invests in commercial buildings in the southeast may match your view of a bullish market.
• How long has the real estate trust been around? Location, location, location, location, experience and market knowledge are key.
• FFO. Funds From Operations is the metric used to analyze a REIT’s cash flow. It is calculated by adding depreciation and amortization back to income. It is sometimes quoted on a per share basis. The FFO ratio is used like an Earnings Per Share ratio.
What are some REIT risks:
• Too much supply. If an area is considered “hot”, builders may rush in and put up an oversupply of buildings. When this happens, it’s great if you’re a tenant. Stinks if your the landlord.
• High interest rates. High interest rates make construction costs expensive and projects will slow down. Buildings must be up and running to collect rent.
• Funding. Since real estate trusts pay most of their income to investors they must fuel growth externally. Many times they will turn to the equity markets to generate cash. During a bear market this alternative is not so attractive.
If you’re looking for capital appreciation, real estae trusts are not short term investments. As I said, about 90% of the income is distributed to shareholders via dividends. The shares have a minimal increase in value from year to year.
If you want to minimize your taxes and don’t need income, you may want to look elsewhere. The dividends you receive are considered taxable income.
The returns are comparable to the S&P 500 and REITs are not as volatile. Real estate trusts often increase their dividend payment from year to year. You can receive a steady source of income.
If you want to invest in real estate without having to fix your tenant’s toilet on a Sunday morning, a REIT makes a great diversification.
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Inflation does not affect a REIT’s value. As interest rates rise, so does the rent. It's a rare occasion when the landord tells his tenants he'll be decreasing the rent next year. Real estate trust are a liquid market and easy to buy.
You can invest in a geographic territory or a type of income producing property. Think health care facilities are going to take off as the country ages? There are REITS that invest in everything from rehabilitation centers and nursing homes to psychiatric hospitals and medial office buildings.
Ok. A REIT may not make you a real estate millionaire. But people will think you are.
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