In a previous article, I discussed five ways that a person and especially an expat can invest their money other than through stocks and bonds. This next article discusses what a real estate investment trust (REIT) is and why someone should take advantage of this kind of investment opportunity. So what is a real estate investment trust or REIT?
A real estate investment trust is when a company owns and typically operates real estate which generates income. Note that this is different from when an individual owns real estate for the purposes of generating income. REITs are part of a fixed-income portfolio or part of the company’s portfolio. There is another major difference in a REIT compared to other real estate companies and that is that a REIT does not engage in the development of real estate properties to resell them. Instead, when there is a REIT that is established, properties are bought and developed so that the company can include them as part of its portfolio. Your next question may be, why should I invest in a REIT? What are the benefits for me to do this? REITs provide a way for you as an investor to earn a share of the income that is produced through commercial real estate without you having to go and buy commercial real estate. REITs generate dividend income.
There are many examples of what is a REIT. This includes property such as an apartment complex, health care center, office buildings, retail centers and warehouses.
The business model of most REITs is straightforward. The company that has established the REIT is able to lease space and collect rent on the property and then the income generated is distributed as dividends to shareholders. But establishing an REIT isn’t as easy as some may think because it doesn’t happen overnight. Companies that decide to establish REITs must meet certain specific requirements outlined in the Internal Revenue Code. These requirements include:
- Having to invest at least 75% of its total assets in cash, real estate, or U.S. Treasuries.
- The company must receive at least 75% of its gross income from real property rents, interest on the mortgages financing the real property, or from sales of real estate.
- The REIT must return a minimum of 90% of its taxable income in the form of shareholder dividends every year.
- It must have at least 100 shareholders after its first year in operations.
- The REIT must have no more than 50% of its shares held by five or fewer people during the last half of the tax year.
There are different types of REITs and for the purposes of this article, I will list and describe five of them.
The first kind is a retail REIT. A retail REIT is found in a shopping mall. If you are an expat or even a U.S. citizen, make sure that you remember that at the most basic level, retail REITs make money from the rent that they charge tenants. A fact of life is that every property and business owner has to have a consistent cash flow in order to survive and prosper. If a retailer is having a cash flow problem due to poor sales, it is likely that they could delay or even default on those monthly payments and when that happens, the REIT will dissolve. Also, finding new tenants is never easy. Once you have assessed your REIT, it is then important to focus on the type of REIT that you will be investing in. Also, in economic downturns, retail REITs with stronger financial positions will have opportunities to purchase real estate at lower prices. However, there is one big long-term concern that those of us that want to invest in retail REITs will face. Shopping is moving online and owners that have space have basically been forced to innovate and change their strategy. They have attempted to fill their space with offices and other non-retail oriented tenants but even so, this sector is facing increasing pressure.
A residential REIT is when multi-family apartment buildings are owned and operated. Another type of residential REIT that is common is manufactured housing. If you wish to invest in this type of REIT, there are several factors to consider. For instance, the best apartment markets in terms of yield tend to be cities that have lower home prices relative to the rest of the country that you are living in. This applies as a consideration whether you are living in the U.S., Mexico, or China. When you want to invest in a residential REIT, there are two main factors to be aware of and take into consideration. These factors are population and job growth. When there is a net inflow of people to a certain city it is because there are plenty of jobs and the economy is growing. In a growing situation such as this, you as the investor stand to profit enormously. Residential REITs should continue to do well in cities where the apartment supply remains low and demand for them rises.
A healthcare REIT is when the investor invests in the real estate of places such as hospitals, medical centers, nursing facilities, and retirement homes. The success of this type of REIT depends upon how the healthcare system of that country is functioning.
As the name of this type of REIT implies, when you invest in this type of REIT you are investing in office buildings. You will receive rental income from tenants that have signed leases (usually long-term). There are four questions that any investor should consider when they want to invest in this type of real estate:
- What is the state of the economy in my chosen city or country and how high is the unemployment rate?
- What are the vacancy rates in my city?
- How is the area in which I’ve invested doing economically?
- How much capital is available for acquisitions?
A mortgage REIT is a REIT that some investors choose to invest in more than the others I mentioned. This type of REIT invests in mortgages as opposed to equity. Mortgage REITs are not risk-free, though. If interest rates go up, there will be a decrease in mortgage REIT book values and stock prices will go down. In addition to this, future financing will be more expensive and this expense will result in the reduction of a portfolio of loans.