REIT (Real Estate Investment Trust)

What is an REIT? An REIT (sometimes called the Real Estate stock) is a company that uses the pooled capital to purchase and manage (mostly income based) properties. It is basically the mutual fund of the real estate industry. It uses the combined investment of many to purchase a Real Estate property. Investing in Real Estate is a great way to increase your income, but for many people, Real Estate investment can be very difficult (especially commercial Real Estate) and hence an REIT makes it easy for common people to own a part of Real Estate instead of just affluent people owning it. How does it work? It works like a mutual fund allowing both large and small investors to own a share of Real Estate. It can be publicly of privately held. Anyone can buy shares in a publically traded REIT and basically get the benefits of Real Estate ownership without the headaches or at the expense of being a landlord. REITs can also be non-exchange traded i.e. registered with the SEC but not traded on any of the public exchanges. Instead, they have private sponsors who market them to investorsoften those who have been burned elsewhere in the market and seek relative stability. What are the different types of REITs? 1. Equity REIT: These types of REITs allow investors to own properties and generate income by renting them out. Equity REITs are different from typical real estate developers because they purchase or develop real estate to operate it as part of their portfolios instead of developing it for resale. Equity REITs are considered superior for the long-term investing because they earn dividends from rental income as well as capital gains from the sale of properties. 2. Mortgage REIT: These allow investors to own property mortgages, purchase mortgages from lenders and loan money from mortgages. The profits in these are earned by the interests earned in mortgage loans. Rather than investing in properties, Mortgage REITs loan money for mortgages to real estate owners or purchase existing mortgages or mortgage-backed securities. Their revenue is generated primarily by the interest that they earn on the mortgage loans. Mortgage REITs react more quickly to changes in interest rates than equity REITs because their dividends come from interest payments. 3. Hybrid REIT: These are investments that combine equity and mortgage REITs. Another classification of REITs is open end and closed end REIT. A closed REIT can issue shares to public only once and can issue additional shares only by diluting the stock (this can be done if the current shareholders approve). Open ended REITs can issue new shares and redeem shares at any time. History of REITs REITs came about in 1960, when President Eisenhower decided that smaller investors should also be able to invest in large-scale, income-producing real estate. It determined that the best way to do this was the follow the model of investing in other industries -- the purchase of equity. What are the advantages of REITs over other investments? REITs are seen as very liquid assets that can be sold and traded very easily and traded like stocks. By law, REITs must pay out 90% of profits as dividends to investors to qualify for special tax considerations as per the IRS (only in the US). REITs have an advantage over other types of stocks. Because of their pass-through taxation, REITs have greater profits from which to pay shareholder dividends than similar sized corporations. As long as a REIT maintains its tax-qualified status by paying out 90 percent of its net income to common shareholders, it doesn't have to pay federal income taxes. Without a tax bite to reduce profits, shareholders get more of the REIT's earnings. REIT investors receive value in the form of dividend income and potential share value appreciation. Because REIT income often comes from commercial properties with long lease periods, REITs can offer a relatively predictable revenue stream. They also are somewhat resistant to inflation. Unlike bonds with pre-determined rates of interest, which lose relative value in times of high inflation, REITs with rental incomes adjust themselves in line with the cost of living. This makes them less vulnerable to inflation-related devaluation.

How to select an REIT? A past performance is no indicator of the future performance of an REIT; so, one must consider demographic information such as population growth, employment growth and the level of economic activity for the particular area or industry. These will have a direct impact on rent levels and occupancy rates -- which in turn affect cash flow and dividends. It is very important to evaluate your needs. Another important factor is: knowing the REIT management well. Some key statistics to examine an REIT are: Net asset value (NAV), Funds from operations (FFO) and adjusted funds from operations (AFFO). The National Association of Real Estate Investment Trusts (NAREIT) defines FFO as: Net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis. Are they global or local? Real Estate has always been more of a local affair. Many REITs are geographically based (particular area) or on property types (healthcare facilities or apartments or industrial facilities). This is mainly due to the extremely localized nature of real estate. Although some REITs have a broad focus and invest in a variety of property types in a range of locations, many REITs focus their investments either geographically or by property types. An individual REIT may hold properties only in a specific region, state, or metropolitan area. Or, it may hold properties across broader geographical areas but focus on healthcare facilities, apartments or industrial facilities. REITs are now global: Nearly 30 countries have adopted variations of the U.S. REIT model. Today, anyone in the world can invest in REITs around the world.