What Is a Real Estate Investment Trust (REIT)?
09-22 15:00uSMART

 

I . What Is a Real Estate Investment Trust (REIT)?

Real Estate Investment Trust is also known as a Real Estate Trust. It is an investment vehicle similar to a closed-end mutual fund, but invests in real estate. Investment trust was created by the United States Congress in 1960, mainly through the securitization of real estate and the fund raising of many investors, so that ordinary investors without large capital can also participate in the real estate market with a low threshold, and gain profits from real estate market transactions, rent and appreciation. At the same time, investors do not need to actually hold the real estate, and can be traded in the securities market, so the market liquidity is better than real estate.

 

Real estate investment trusts (REits) are characterized by the fact that their main income comes from rent, so their returns are relatively stable, and the trust must use most of its future surplus as dividends. Because of this, the dividend payout ratio of real estate investment trusts is much higher than that of the average market stock.

 

KEY TAKEAWAYS

  • A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing properties.
  • REITs generate a steady income stream for investors but offer little in the way of capital appreciation.
  • Most REITs are publicly traded like stocks, which makes them highly liquid (unlike physical real estate investments).
  • REITs invest in most real estate property types, including apartment buildings, cell towers, data centers, hotels, medical facilities, offices, retail centers, and warehouses.

 

II . How Does REIT Work?

Congress established REITs in 1960 as an amendment to the Cigar Excise Tax Extension. The provision allows investors to buy shares in commercial real estate portfolios—something that was previously available only to wealthy individuals and through large financial intermediaries.

 

Properties in a REIT portfolio may include apartment complexes, data centers, healthcare facilities, hotels, infrastructure—in the form of fiber cables, cell towers, and energy pipelines—office buildings, retail centers, self-storage, timberland, and warehouses.

 

III. Types of REITs

There are three types of REITs:

 

  1. Equity REITs. Most REITs are equity REITs, which own and manage income-producing real estate. Revenues are generated primarily through rents (not by reselling properties).
  2. Mortgage REITs. Mortgage REITs lend money to real estate owners and operators either directly through mortgages and loans, or indirectly through the acquisition of mortgage-backed securities. Their earnings are generated primarily by the net interest margin—the spread between the interest they earn on mortgage loans and the cost of funding these loans. This model makes them potentially sensitive to interest rate increases.
  3. Hybrid REITs. These REITs use the investment strategies of both equity and mortgage REITs.

 

REIT Types Comparison

Type of REIT

Holdings

 

Equity

 

Owns and operates income-producing real estate

 

Mortgage

 

Holds mortgages on real property

 

Hybrid

 

Owns properties and holds mortgages

 

IV. Example of REIT

Another consideration when choosing REITs is to look at the sectors of the real estate market that are hot. Which booming sectors of the economy, in general, can be tapped into via real estate? As an example, healthcare is one of the fastest-growing industries in the U.S.—especially in the growth of medical buildings, outpatient care centers, eldercare facilities, and retirement communities.

 

Several REITs focus on this sector. Healthpeak Properties (PEAK)—formerly HCP— is one example. As of April 2022, it had a market cap of nearly US $18.9 billion, with some 4 million shares traded daily.

 

Its portfolio focuses on three core asset classes: life sciences facilities, medical offices, and senior housing, owning interests in more than 615 properties.

 

VI. Advantages & Disadvantages

Advantages

  1. Liquidity
  2. Diversification
  3. Transparency
  4. Stable cash flow through dividends
  5. Attractive risk-adjusted returns

 

Disadvantages 

  1. Low growth
  2. Dividends are taxed as regular income
  3. Subject to market risk
  4. Potential for high management and transaction fees