Thanks to Real Estate Investment Trusts (REITs), you don’t need to be a millionaire to own a piece of real estate. These companies own, finance or operate commercial or residential real estate (income-producing properties). They give investors looking to diversify their portfolio with real estate an opportunity to buy their shares.
As an investor, you don’t have to buy, manage or operate the said properties yourself. Instead, all you have to do is purchase the REITs shares either through a mutual fund, an ETF(Exchange Traded Fund) or as an individual stock. Then, you can enjoy your returns through dividends when the REIT shares its income to shareholders.
Advantages of REITs
Investing in REITs comes with several advantages, mainly:
- Diversification – in investing, you never put all your eggs in one basket. Investing in shares or bonds alone is a pretty risky business. Unless, of course, you are buying shares from companies in different industries. Still, a real estate component would be a great addition to lower the correlation of asset classes in your portfolio.
- High returns – As stated earlier, real estate is among the asset classes to invest in. While it has a higher risk rate than shares and bonds, it also provides a higher return. REITs will expose you to these asset classes when you can’t actually own, run or operate the real estate yourself.
- Affordable – for those of us who cannot afford to buy real estate properties, REITs are a more affordable route for you to get a share of the pie. A quick search of the cost of real estate in major cities, including Nairobi, spits out sums in the range of tens and thousands of millions.
- You are just an investor in a REIT. You are not liable for the management and running of the said properties. Neither are you in charge of managing the REIT itself, especially if you invest in ETF or mutual fund REITs.
- Capital appreciation – you might not own the said real estate, but you still enjoy the benefits of these real estate value appreciation.
- Liquidity – most REITs trade in securities exchanges, increasing their liquidity compared to traditional real estate.
Like any other investment, REITs have drawbacks, too. These include:
- Economic and political environment – investors lose out if these lead to a loss in value or properties or affect interest rates.
- A decrease in leasing rates or letting out the properties leads to reduced income, especially if there is no tenant replacement in good time.
Types Of REITs
You have to keep in mind that not all REITs are built the same. There are three main types of REITs:
Equity REITs are the most common REITs. They own or manage the real estate properties directly, generating income through rent for the REIT. There are numerous sectors of Equity REITs, including:
- Retail REITs own, acquire, develop, manage, or operate retail properties like shopping malls and centres. When investing in one, consider what retail sector the REIT is in and the current and future market prospects. If the industry has high prospects, there’s an opportunity for the REIT to keep generating rental income.
- Residential REITs own and operate income-generating residential properties, like apartments and condominium complexes. Before investing, do some homework. For instance, what’s the location of the properties, the job and population growth? That’s why residential REITs in urban areas with high demand for rental units and affordability are an ideal investment. As long as there’s demand for residential areas with fewer supply, the REIT will make money.
- Office REITs – they are majorly in the office spaces industry. Again, the office buildings’ location matters, so do the state of the economy, employment rates and vacancy rates. For example, if there are high vacancy rates in a particular region, there is a possibility the REITs offices are not fully occupied. That translates to no rental income and low or no dividends on your part as an investor.
- Healthcare REITs – these own, manage or operate in the health sector, where real estate ranges from hospitals to nursing homes, medical centres and retirement homes.
- Lodging – are in the hospitality industry with properties like hotels, resorts and motels.
On the other hand, mortgage REITs (mREITs) are more financiers than owners of income-generating properties. This can be through mortgage backs securities (MBS) or extending credit/mortgage to property owners. mREITs earn money from the interest generated from these credit lines.
Hybrid REITs are just that, a hybrid of both mortgage REITs and Equity REITs. They make money from interest generated in mREITs and rental income from the Equity REITs.
General Considerations When Investing In a REIT
There are several issues to consider when investing in a REIT, apart from the few ones mentioned in some types of REITs:
- The underlying asset and value
- The corporate and management structure of the REIT
- Potential growth of the REIT in EPS (Earnings Per Share)
- The dividend payout ratio as a percentage of the REITs FFO (Funds From Operations)
- Management fees
- Regulations – is the REIT regulated by the necessary bodies?
In the next instalment of investing in REITs, we will talk about REITs in Kenya and how you can invest in them. The industry is fairly new compared to developed countries, but it is here and provides Kenyan investors with an opportunity to diversify their portfolio with a portion of real estate.