REAL ESTATE INVESTMENT TRUST (REIT)
A REIT is a company that owns, operates, or finances income-generating real estate that allows investors to pool their money in a diverse property portfolio. REITs can be publicly traded or via private transactions, distributing dividends from taxable income.
REIT INVESTING
REIT investing is similar to mutual funds, where capital is pooled from multiple investors. This allows individuals to earn dividends from real estate investments without the need to buy, manage, or finance properties themselves.
REASONS TO INVEST
- Historically, REITs have provided competitive total returns through steady dividend income and long-term appreciation.
- REITs can reduce overall portfolio risk by diversifying portfolios and having a low correlation with other assets.
- REITs enable anyone to invest in real estate, not just high-net-worth individuals.
ADVANTAGES AND LIMITATIONS
REITs are essential components of a balanced investment portfolio, providing a robust, steady annual dividend and the potential for long-term capital appreciation. Nonetheless, like any investment, REITs come with their own set of advantages and limitations.
ADVANTAGES
- Attractive passive income: REITs distribute a significant portion of their income as dividends, providing investors with solid total returns.
- Competitive long-term performance: Historically, REITs have performed well, often outperforming stocks and bonds over extended periods.
- High-yield dividends: REITs offer above-average dividend payouts, benefiting from the requirement to distribute 80% of their income to shareholders (Ghana).
- Hedge against inflation: REITs offer a successful hedge against inflation due to their long-term performance and high-yield dividends.
- Portfolio diversification: REITs reduce overall portfolio risk by offering low correlations with stocks and other real estate investments.
- Access to commercial real estate investing: REITs enable individuals to invest in commercial real estate assets that may otherwise be inaccessible.
- Transparent corporate structures: REITs provide transparency through oversight, financial reporting, and independent monitoring.
- Potential for good returns: REITs can generate attractive profits as real estate values tend to rise over time, utilizing strategies that enhance property value through improvements.
- Tangible investment: REITs provide a convenient avenue to invest in commercial real estate without the complexities of direct ownership and management.
- Liquidity (for public traded REITs): Public REITs offer liquidity events, unlike traditional real estate investments, which are less easily liquidated.
LIMITATIONS
- Dividends taxed as ordinary income: REIT investors are subject to income tax on distributions and dispositions, with tax withholding by the REIT on dividends (Ghana).
- Potential high fees: REITs may incur substantial transaction and management fees, potentially misaligned with shareholder interests.
- Not a short-term strategy: REITs are better suited for long-term investors (more than 5 years), as significant dividends leave less capital for rapid growth.
- Limited control over performance or returns: REIT investors' control over real estate investments is limited, as decision-making authority lies with the REIT company.
- Risks associated with specific properties or tenants: Thorough due diligence is essential, as individual property factors can affect investment risks.
- Sensitivity to interest rates: Changes in interest rates can impact REIT profitability and dividend payouts.
AVENUES TO INVEST
Investing in REITs offers two primary avenues: purchasing stocks or shares in either a publicly traded or privately purchased REIT. Understanding the distinction between publicly and privately traded REITs is crucial as it determines the associated risks and benefits.
- Publicly traded REITs are registered with the SEC and are listed on stock exchanges, providing greater liquidity and ease of access.
- Non-traded public REITs are SEC-registered but not traded on stock exchanges. They are offered through brokers or financial advisers with high upfront fees.
- Private REITs, unlike publicly traded ones, are exempt from SEC registration and do not trade on national stock exchanges. They can be bought through financial advisors at brokerages, and investors need to check if they qualify as accredited investors.
It's important to note that not all REITs are publicly traded, making them more challenging to invest in and potentially requiring a larger investment. Choosing between publicly traded and privately purchased REITs should be carefully considered based on individual financial goals and risk tolerance.
DIFFERENT TYPES OF REIT ASSETS
Various REITs own different real estate assets, each with distinct benefits and considerations. Depending on the type of assets, investors may encounter varying risks and returns. REITs can include office space, retail space, flex space, and various combinations of assets.
- Residential REITs focus on homes, apartments, and student housing. They thrive in growing areas but are sensitive to interest rates and economic policy changes.
- Lodging/Hotel/Resort REITs handle hospitality properties like hotels and resorts, performing well in a strong economy but facing challenges during downturns.
- Industrial REITs focus on warehouses and distribution centres, benefitting from long-term leases and e-commerce growth. However, they can be risky due to dependence on the global economic market.
- Healthcare REITs manage hospitals, nursing homes, and assisted living facilities, driven by the ageing population's demand.
- Retail REITs handle retail locations like outlet malls and shopping centres, benefiting from favourable lease agreements and triple net leases. However, challenges emerge from the shift to online shopping and declining retail centre traffic.
- Office REITs manage office spaces, characterized by longer leases but influenced by economic growth and stagnation.
- Hybrid REITs invest in a diverse mix of real estate assets, combining various property types in their portfolio. This offers potential benefits in risk mitigation and stability but comes with the challenge of managing diverse sectors.
DIFFERENT TYPES OF REIT SECTORS
REITs are categorized into sectors based on their property makeup, trading methods, and represented sectors.
- Equity REITs generate income from renting existing real estate to tenants, distributing dividends after covering property management fees and operational expenses.
- Development REITs develop properties to generate income in the future by enhancing the value of their properties and generating rental income once completed.
- Mortgage REITs generate income from interest on mortgages, offering high-interest payouts on commercial mortgages.
- Hybrid REITs offer a blend of equity, development and mortgage holdings, providing portfolio diversity and protection from market fluctuations.
- Public non-listed REITs are registered with the SEC but not traded on the national stock exchange.
- Publicly traded REITs are both registered with the SEC and traded on the national stock exchange, providing high liquidity.
- Private REITs are real estate funds that don't trade on the stock exchange, limited to institutional investors.
GENERATING PROFITS THROUGH REIT INVESTING
REIT investing involves a company acquiring real estate, leasing the properties to generate rental income, and then distributing that income to shareholders as dividends. Shareholders can also benefit from potential stock growth, as the value of their shares may increase based on the appreciation of the underlying properties within the REIT. Successful REITs aim to build value by expanding their portfolio with cash-flowing assets or through strategic property sales. Investors can profit from rising rental income and occasional property sales proceeds.
Publicly-traded REITs offer easy accessibility to investors, allowing them to buy, sell, or trade shares online, similar to regular stocks. On the other hand, privately traded REITs require brokerage services and are typically limited to accredited investors.
To ensure successful REIT investments, it is crucial to carefully consider how these investments align with your existing investment portfolio and financial goals. Proper portfolio diversification and understanding the specific risks and benefits of REITs are essential in making informed investment decisions.
HOW REITS PAY INVESTORS
REITs in Ghana are mandated to distribute a minimum of 80% of their net earnings to shareholders as dividends. This means that regardless of the REIT type, dividends are always paid to investors. Dividends are sourced from rental income, capital gains, and other earnings like profits from property sales. However, the amount of dividend payouts is contingent on the success of the REIT; if there are no profits, shareholders will not receive dividends.
ASSESSING A REIT BEFORE INVESTING
Before investing in a REIT, it's crucial to conduct thorough assessments to ensure a viable investment. Consider these key factors:
- Review the portfolio of properties, analyzing existing tenants, lease terms, rent collection, acquisitions, and dispositions. Pay attention to tenant business health, lease lengths, rent history, and overall portfolio growth.
- Evaluate the shares/stocks valuation, including funds from operation (FFO), price to FFO, adjusted funds from operation (AFFO), and net asset value (NAV) to understand true earnings. (1) Examine the dividend history and payout ratio to gauge the sustainability of dividend growth. (2) Analyze the debt structure, including earnings before interest, tax, depreciation and amortization (EBITDA), debt maturity schedule, interest rates, and costs.
- Assess the personnel and management team's performance, as they play a crucial role in the company's success.
Additionally, consider investment liquidity based on the REIT sector and the possibility of reinvesting dividends for gradual growth.
Although some investors may conduct their due diligence, working with qualified financial analysts who specialize in reviewing REITs can be highly advantageous. These experts offer valuable insights for making well-informed investment decisions.
DETERMINING REIT ALLOCATION IN YOUR PORTFOLIO
Determining the appropriate allocation of your portfolio to REIT investing involves considering diversification. Generally, setting aside a portion of your portfolio, typically ranging from 5% to 20%, for real estate investments is a common practice. This allocation aims to balance risk, improve returns, and safeguard against inflation. For personalized investment decisions, it is essential to seek advice from a financial advisor, considering your unique financial goals and circumstances.
RISK AND CONCLUSION IN REIT INVESTING
While REIT investing can be a promising strategy, it comes with certain risks. These risks are common to any investment with significant potential for returns. It's essential to be aware of the following risks before venturing into REIT investing:
- A decline in demand for office, industrial, retail or other spaces may impact the income potential of REIT dividends.
- Illiquidity: REIT investments may be challenging to liquidate quickly if immediate liquidity is required.
- Economic and regulatory changes can affect the real estate market, potentially leading to a decrease in investment value.
- Market conditions, both locally and globally, can influence tenants' financial conditions.
- Government regulations may affect tenant operations or renovations, subject to regulatory changes.
- Vacancies in REIT properties can affect dividend payouts or reduce the value of potential property sales.
Despite the risks, REIT investing offers potential benefits, such as portfolio diversification, competitive returns, and accessible entry into the real estate market. However, it's essential to be aware of associated risks, including market fluctuations and regulatory changes. Taking these risks into consideration is an integral part of the due diligence process. Always conduct proper due diligence and consult with a financial advisor before making any investment decisions.