The globalisation of real estate as an asset class has shot up the popularity of Real Estate Investment Trusts (REITs). These investment vehicles gather capital from various investors and allocate them towards income-generating assets such as commercial buildings, apartments, and infrastructure. As investors seek new ways to obtain access to an expanding institutional market, REITs allow them to gain exposure to real estate assets without physically owning or managing properties, providing liquidity and diversification in their investment portfolios. Moreover, REITs deliver competitive returns revolving around high, steady dividend income and long-term capital appreciation. However, these types of investments come with strict compliance rules, the misinterpretation and ignorance of which can crucially impact a REIT and its investor. Therefore, the investor must conduct proper research, weigh merits and demerits, and turn to effective structuring and monitoring to untap the maximum potential of REIT. In the longer run, it will act as an excellent portfolio diversifier and help lessen the overall portfolio risks.
Different Types of REITs
Equity REITs
The majority of REITs are equity REITs that provide an equity ownership position in a diverse portfolio of commercial real estate holdings. Investors receive a pro-rata part of the underlying assets’ cash flow and earnings in exchange. Most equity REITs focus on a single asset class, such as shopping centres, data centres, self-storage facilities, or healthcare facilities.
Mortgage REITs
Mortgage REITs offer financial support for buying real estate properties, with a preference for investing in residential mortgages over commercial ones. However, they have the option to buy loans for any type of income-generating property.
Public Non-Listed REITs
Non-publicly traded REITs are not listed on public exchanges for trading. Although these REITs may concentrate on particular asset types, they are not particularly liquid due to their lack of ease in being bought and sold on public exchanges.
Private REITs
These are also known as non-traded REITs and are spared from legal requisites as long as they abide by specific rules. Private REITs can only sell shares to accredited investors and do not trade on public exchanges, which makes them less liquid compared to those publicly traded REITs.
Hybrid REITs
The investment strategies in Hybrid REITs are a combination of both equity and mortgage REITs. It owns both properties and mortgage loans, making them more diversified, beneficial, less risky, and an attractive investment alternative.
Rental REITs
A Rental REIT scheme invests in commercial or residential Real Estate to generate rental income. The scheme purchases a fully constructed property and rents it out, distributing the resulting revenues among the unit holders.
Developmental REITs
In this type of REIT, the land is bought with the aim of developing commercial, residential, or industrial real estate via construction or renovation and eventually sold or rented. The profits yielded are then dispensed to unit holders.
Retail REITs
It consists of businesses engaged in purchasing, developing, owning, leasing, and managing retail properties. Retail real estate investment trusts (REITs) include those that concentrate on larger regional malls, outlet centres, grocery-anchored shopping malls, and power centres with big box shops. Retail REITs generate income from the rent they charge tenants.
Industrial REITs
It is made up of businesses that buy, build, own, rent, and operate industrial warehouses, distribution centres, and other properties. These REITs are crucial to e-commerce and aid with supplying the demand for quick delivery. Industrial REITs are designed so that they can be altered to suit tenants’ preferences and varying uses.
Lodging REITs
Lodging REITs own, operate, purchase, build, rent, manage, and lease out space in hotels and resorts to travellers. Based on attributes, including the hotels’ level of service and amenities, lodging REITs own several kinds of hotels. Customers for the properties owned by lodging REITs range from tourists to corporate travellers. The general public can rent their rooms and conference facilities. Although buying and selling real estate is a regular aspect of a hospitality REIT’s operations, it is not the main source of revenue.
What are the Merits of REITs?
Low Entry Barrier
Big or small investors can invest in REITs provided they have a brokerage account and sufficient cash on hand to buy at least one share of a publicly traded REIT. REITs are a terrific way for small-scale retail investors to gain exposure to the real estate industry and generate passive investment returns.
Diversification of Holdings
The investor will have a varied investment portfolio of real estate assets if they invest in any sort of REIT. Aside from providing diversity from conventional stock markets investments like mutual funds, investors can opt to diversify further within the REIT asset class by purchasing REITs that concentrate on certain real estate assets, such as retail REITs, office REITs, or healthcare REITs.
Capital Appreciation
REITs have the potential to provide a return on investment as capital appreciates over time and generates profit for stakeholders. Thus, they can act as a source of passive income and a vehicle for long-term investment.
Liquidity
Purchasing and selling physical properties can be time intensive, and the investor might incur high costs. However, investments in public and private REITs are much more convenient and effortless as it allows buying shares that can liquate and be sold immediately.
Tangible Assets
REIT assets are tangible, meaning they can be seen and touched, unlike other asset types like stocks. These types of investments are resilient to short-term market fluctuations as well.
What are the Demerits?
Limited Control
Where direct real estate investors have great control over their returns, REIT investors have limited control over their shares’ performance and returns. They can only sell it if they do not like the performance. Private REIT investors, on the other hand, have to wait for a few years before putting on sale.
No Guarantee of Returns
Returns from REITs are not promised like other investment alternatives such as stocks or mutual funds. Thus, they are not suitable for risk-averse investors. However, these investments come with low risk.
Appreciates Slowly
REITs offer productive long-term returns as real estate assets appreciate slowly over time. So investors looking for immediate returns in the short term may go for equity stocks instead of REITs.
Volatile
REITs are prone to volatility like other real estate investments. They are often influenced by real estate market trends or a specific type of property falling in or out of consumer demand. For example, if a REIT has an investment in residential properties in a location with dwindling rental income, then the returns of the shareholders are likely to trend downwards.
Tax on Dividends
Investors should be aware that dividends earned from REITs may be subject to higher taxes compared to other investments. While typically only a capital gains tax is required on dividends, this is not the case for REIT returns as they are subject to ordinary income tax rates. The tax rates may vary depending on the country of residence.
Conclusion
The commercial real estate market has expanded exponentially worldwide, with REITs emerging as a popular form of real estate investment for those looking for decent returns. These come with ample benefits of passive income, portfolio diversification, liquidity and so on. However, investors should conduct thorough research and weigh all the pros and cons before investing in the type of REIT that suits them best.
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