Real Estate Investment Trusts (REITs) are investment mechanisms that operate based on the pooling together of funds from different sources and directing such funds to real estate ventures. The persons investing in REITs have the right to a share of the profits generated through periodic or one-off payments.
Typically, REITs invest their funds in various assets in the real estate sector by purchasing, building, or lending assets and making profits from price differentials. The resultant income is shared among the shareholders, depending on their stake in the trusts. Some of the assets preferred by REITs include office blocks, apartments, shopping malls, warehouses, and hotels.
REITs can be broadly categorized into three, namely, Publicly Traded, Public, Non-traded, and Private. Publicly Traded REITs are regulated entities listed in securities exchanges such as NYSE, where their shares are traded.
On the other hand, Public Non-traded REITs issue shares to investors but are not listed in securities exchanges. However, the SEC still exercises regulatory authority over them.
Finally, Private REITs are investment pools from a closed circle of investors who raise the required funds for the trusts instead of open-sourcing from the public. They are therefore not regulated by the SEC.
Apart from the source of funds and share trading, the other significant difference among the three forms of REIT is the level of liquidity, which is comparatively higher in Publicly Traded REITs than the other two.
How to buy and sell REITs
For publicly traded EITs, their listing in exchange markets means that you can invest in them like any other stock, using a broker to place your order to either buy or sell. If interested in public Non-traded REITs, your entry point will be through a broker who has access to the trust’s offered shares. The other option is to go for alternative securities such as ETFs and mutual funds.
Types of REITs
1. Retail REITs
As you may infer from the name, these are REITs that have invested in the retail sector. They are the most popular REITs, with about a quarter of the market. This is explained by the fact that many businesses are coming up each day, and all these businesses need premises. Investors prefer them because the revenue streams from businesses are more reliable than others because they have to pay rents to remain in operations.
The downside to this is that the economy periodically goes through widespread shocks such as recessions or reduced consumer spending, which may compromise the ability of some businesses to pay their rents.
When businesses close shop, it may take a significant amount of time before new tenants come on board. This may result in periods of reduced income from the retail investments. Therefore, you need to evaluate the current economic situation and try to create a future outlook out of it before investing in retail REITs.
2. Mortgage REITs
This is another popular type of REIT, as a result of the relatively good uptake of mortgages. For REITs, their business model is built on the sale and buying of mortgage securities in the secondary market. This offers investors an alternative way to benefit from mortgages apart from investing in real estate.
The risk levels in these REITs are mostly related to the changes in bank interest rates. When interest rates rise, the uptake of their products reduces considerably because higher interest makes mortgage refinancing expensive. In the end, the value of the assets held end up reducing, leading to a reduction in the income channeled to investors.
3. Residential REITs
They invest in housing units/buildings that typically house families and individuals. The REITs either rent out or sell apartments and homes, meaning that the performance of their investments depends on several dynamics, key among them being the location of the properties.
For example, some estates are considered more prime and high-end, while housing demand is higher in some areas than in others. You should therefore evaluate where the REIT’s core investments are located to help you make better decisions.
Disadvantages of REITs
- Economic conditions may trigger reduced rental income and high rates of default on mortgages, leading to reduced income for investors.
- Unfavorable economic and political climates may lead to reduced demand for property, leading to value depreciation.
- REITs face stiff competition from alternative investment options such as stocks and T-bills, which often affect their performance in different economic cycles.
- Some REITs keep investors’ funds for a specific period. These are called close-ended REITs. If you have your money invested in this type of trust, it may be challenging for you to withdraw your funds unless the trust sells your shares.
- Regulatory limitations on investing in REITs: There’s a limit to the percentage of capital that some investment funds can direct towards REITs. For example, pension schemes cannot invest more than 30% of their assets in the trusts.
Benefits of REITs
- Publicly traded REITs must reveal their accounts for public scrutiny since they issue shares traded in securities exchanges. This promotes transparency and builds investors’ confidence.
- Land-based assets typically appreciate in value over time, even when they are not sold or rented. This, therefore, means that investors are almost certainly assured of good returns.
- They have a relatively low correlation with most assets traded in stock exchanges, which minimizes risks when such assets perform poorly.
- Publicly traded REITs issue shares that can be easily liquidated in exchange markets.
- They give back high dividends to investors, usually 90%+ of profits generated.
Bottom line
REITs are valuable and worthy investment ventures and they offer investors various options to choose from. One should consider investing in them once they understand their needs and the relationship between REITs and the performance of the economy.
