Real Estate investment going up in the U.S. Say what?
By: Eran D. Grossman
Yes that’s right. With growing concern about a commercial real estate bust and home prices continuing to fall, real estate stocks are soaring. What you say?
Shares of Real Estate Investments Trusts, a/k/a REITs, are lucrative investment vehicles thus far in 2010. The IShares Dow Jones Real Estate exchange-traded fund, which owns about seventy-five real estate stocks, is up 9% in 2010.
So what is a REIT? A REIT is a security that sells like a stock on a major exchange and invests directly in real estate, either through properties or mortgages. The name REIT comes from its tax designation status for corporation’s investing in real estate which reduces or eliminates corporate income taxes. A REIT is required by law to distribute 90% of its income, which may be taxable, to its investors. The REIT structure was designed to provide for investment in real estate as mutual funds provide for investment in stocks. Like other corporations, a REIT can be held publicly or privately, and a public REIT can be listed on a public stock exchanges like shares of common stock. A REIT can be classified as equity, mortgage or hybrid.
An Equity REIT invests in and owns properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties’ rents. A Mortgage REIT deals in investment and ownership of property mortgages. This type of REIT lends money for mortgages to owners of real property, or purchases existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans. Evaluating the risk of default is clearly something the REIT and its investor should watch out for. A Hybrid REIT combines the investment strategies of an equity REIT and a mortgage REIT by investing in both. REITs usually invest in commercial buildings, shopping malls, residential buildings, warehouses and hotels. Some REITs invest specifically in one area of real estate or in one geographical region, state or country.
So what’s the attraction? One word- Yeild. Since REITs in the U.S. pay at least 90% of their taxable income to shareholders in the form of dividends, this exempts the REIT from paying federal income tax. For this reason REIT’s tend to earn high dividend yields that make them more intriguing than treasury bonds, especially during a low interest rate environment such as now.
Bear in mind, as with any security, invest wisely and diversify.
Very interesting post Eran but I have a few questions:
1. What are the advantages and disadvantages for an investor with the three types of REIT?
2. Are REITs tend to be involved with more commercial or residential real estate or is is really mixed?
3. Could you give a basic outline of how a REIT is structured?
Regarding your first question, the investor must assess for themselves what type of REIT they wish to invest into- there are many. This depends of course on the markets, the real estate industry as a whole and which sectors within that industry are (under)performing. Moreover, the catogories of REITs simply classify the type of real estate product the REIT invests into so that the investor has this knowledge upfront. For example, its similar to a hedge fund that invests only in the energy sector. So its up to the investor to research and decide what type of REIT is right for them.
2) To your second question, REITs are involved in both residential and commercial or a hybrid of both. For example, some deal only in hotels, or only in commercial office buildings. Thus if the commercial real estate market is doing well in terms of occupancy, valuation, construction, rents etc.- these are the factors to weigh when deciding if such a REIT is for you.
3) As indicated above, a REIT is structured to distribute 90% of its income to its investors and thus can avoid paying federal corporate tax. The investor is taxed on income but not the REIT (which is a corporation with a REIT designation). This was designed to provide for investment in the real estate industry as mutual funds provide for investment in stocks. Its a grouping of different real estate assets (like a stock in mutual funds) pooled together to form the trust (as a mutual fund groups together different stocks).