With the recent events in the sub-prime market and the decline of the housing market (and no signs of quick recovery), I thought now would be a great time to discuss REIT’s. What they are, their investment advantages/disadvantages, and when to buy (or not to!).
REITs (Real Estate Investment Trusts) are companies that own and actively manage income-producing commercial properties. These include apartment buildings, warehouses, office properties, shopping malls, hotels, storage centers, and health care facilities. Some REITs invest in loans that are secured by real estate. Shares of REITs are publicly available on the stock exchange. The purpose of REITs is to allow investors to invest in large-scale real estate ventures and a collection of diversified properties that they could not normally do. REITs are useful in a diversified portfolio for dividend income, tax benefits, and risk allocation. It is also a liquid investment- unlike trying to sell a warehouse or industrial building, unloading shares of REITs is easy and timely. A REIT is known as a “pass through” investment, because the company does not have to pay corporate taxes- instead, the income is passed to shareholders and they are personally taxed, thus avoiding double taxation.
REITs have high dividend yields- they are required by law to distribute 90% of their yearly taxable income to shareholders. Between 1995 and 2000, the average REIT yield was 7.3% - six times the average yield of the Russell 2000.
REITs (Real Estate Investment Trusts) are companies that own and actively manage income-producing commercial properties. These include apartment buildings, warehouses, office properties, shopping malls, hotels, storage centers, and health care facilities. Some REITs invest in loans that are secured by real estate. Shares of REITs are publicly available on the stock exchange. The purpose of REITs is to allow investors to invest in large-scale real estate ventures and a collection of diversified properties that they could not normally do. REITs are useful in a diversified portfolio for dividend income, tax benefits, and risk allocation. It is also a liquid investment- unlike trying to sell a warehouse or industrial building, unloading shares of REITs is easy and timely. A REIT is known as a “pass through” investment, because the company does not have to pay corporate taxes- instead, the income is passed to shareholders and they are personally taxed, thus avoiding double taxation.
REITs have high dividend yields- they are required by law to distribute 90% of their yearly taxable income to shareholders. Between 1995 and 2000, the average REIT yield was 7.3% - six times the average yield of the Russell 2000.
The combination of high dividend yields and the capital appreciation of the real estate properties results in total returns on average higher than the S&P 500. (See below)
Source: National Association of Real Estate Investment Trusts
So how do you compare REITs? The industry standard metric for REIT performance is FFO (Funds from Operation). This measures the performance of the REIT excluding historical depreciation. When looking to buy a REIT, you should compare REITs using this metric. You should also analyze the managers- look for a quality manager that has survived or performed well relative to the REIT market in down cycles. Look for REITs where more than 10% of the ownership is from insiders- if they’re selling, they know something you don’t and you don’t want to buy. Also look for REITs that invest in a large geographic area- it is important for a high-return REIT to be diversified in geographic area and in property type so a long downturn in a specific region won’t devastate your total return.
So how do you compare REITs? The industry standard metric for REIT performance is FFO (Funds from Operation). This measures the performance of the REIT excluding historical depreciation. When looking to buy a REIT, you should compare REITs using this metric. You should also analyze the managers- look for a quality manager that has survived or performed well relative to the REIT market in down cycles. Look for REITs where more than 10% of the ownership is from insiders- if they’re selling, they know something you don’t and you don’t want to buy. Also look for REITs that invest in a large geographic area- it is important for a high-return REIT to be diversified in geographic area and in property type so a long downturn in a specific region won’t devastate your total return.
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