Methodology

Investing Basics

Module 2

What is a portfolio?

Real Estate Investment Trusts

If you have ever wanted to invest in real estate but haven’t had the money to buy a property in full, real estate investment trusts are a great solution. Real estate investment trusts (REITs) allow investors to invest in property, without having to do all of the hard work. Instead, the management of the REIT will buy and manage the investments.

 

REITs can either be in the form of an investment fund or just as a company that invests in real estate. So, as an investor, you have the option to either become a shareholder within a property company or invest in a fund that owns property 

 

It’s possible to find REITs for all types of real estate, whether it be commercial or residential. The companies usually specialise in a particular type of real estate, distributing rental payments to investors. Many REITs are publicly traded on a stock market and can be found through a stockbroker.

Types of REIT

There are 3 types of REIT, which are Equity REITs, Mortgage REITs and Hybrid REITs.

 

Equity REITs own and manage income-producing real estate for investors. Equity REITs make money for investors by distributing rental payments to them or by holding properties that become more valuable over time.

 

Mortgage REITs raise funds and lend the money to real estate owners and operators, in the form of a mortgage or loan. The mortgage REIT earns money when their clients pay interest on the money that they borrowed. Alternatively, mortgage REITs can indirectly lend money to homeowners by purchasing mortgage-backed securities. Mortgage-backed securities are financial instruments that group mortgages together, with the investor providing funding for all mortgages. Mortgage REITs may also borrow money themselves and lend that money to prospective homeowners, making money by charging a higher interest rate than they pay on their own debt.

 

Finally, hybrid REITs do both investment activities that equity and mortgage REITs undertake. They own and manage property but also lend money to new homeowners. 

The limitations of investing in a REIT

REITs are a great way to invest in property if you do not have the funds to buy a property in full. They are particularly useful if you would like to own an interest in large facilities, like a shopping mall or airport.

 

Although REITs sound like a great opportunity to invest in real estate, they do not come without drawbacks. Firstly, to qualify as a REIT, property funds or companies need to pay at least 90% of their income to their investors. This means that the fund or company is only left with 10% of their income, making it hard for them to expand in size, whether that be by purchasing new properties or by lending more money to new homeowners. For example, if a company holds 10 properties that generate income of $50,000 a year in rent, they would only be left with $5,000 after distributing 90% of their income to investors. Buying another house with just $5,000 would be impossible, highlighting the limited growth that certain REITs may provide. This is a problem for investors as it means that they will experience limited growth in their real estate investments, which may make other investment types more attractive.

 

Other drawbacks include the fact that REIT income is taxed as regular income in most countries and that many REITs have high management and transaction fees. 

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