We all know about real estate. Houses, apartments, office buildings and factories. But little do we know about Real Estate Investment Trusts (REITs)!
“A Real Estate Investment Trust is a public or private corporation that owns, operates, or finances income-producing real estate and distributes the majority of its taxable income to shareholders in exchange for special tax treatment.” Source: ChatGPT
REITs allow investors to invest into cash flows from property portfolios, instead of buying the real estate itself.
Real Estate Investment Trusts were created in 1960 in the United States. From now on all investors could own a diversified portfolio of commercial real estate.
There are some rules to qualify as a REIT:
- At least 75% of income must come from rents, mortgages or real estate;
- At least 75% of assets must be invested in real estate;
- You must distribute at least 90% of taxable income to shareholders annually;
- There must be at least 100 different shareholders in the trust;
- No 5 shareholders can own more than 50% of the trust;
Real Estate Investment Trusts often offer high dividends because they are legally required to pay these, and usually don’t pay corporate income tax!
Their dividends may often be higher than stock market yields, but don’t come without any potential risks.
There are three major types of REITs:
- Equity REITs, which own and manage properties;
- Mortgage REITs, which only own mortgages;
- Hybrid REITs, which are a combination;
Furthermore, Real Estate Investments Trusts can be categorized into residential, office, retail, industrial, logistics, hospitality, healthcare and specialized REITs.
Because real estate requires a lot of money to buy, REITs are often funded by debt. Later they will earn money back to pay off the loans, in the form of monthly rents for example. REITs retain little capital because they distribute most of their income.
It is therefore important to understand that REIT prices are heavily influenced by Central Bank policy. As we have said, REITs are often funded by debt, so interest rates are critical. Their dividends are also compared to yields of other investment classes.
Real Estate Investment Trusts can grow:
- Externally by issuing more shares or buying more properties;
- Internally by raising rents, signing up more tenants, or redevelopment;
It is also important to note that real estate is a local business, unlike stocks of global corporations. REITs are dependent on their local markets.
Real Estate Investment Trusts are especially useful for (passive) income generation, inflation hedging (rent increases) and diversification!
REITs can be bought and sold on stock exchanges like the New York Stock Exchange.
We highly recommend to read the following books on REITs:
- Money: Master The Game by Tony Robbins;
- Unshakeable by Tony Robbins;
- Unconventional Success by David F. Swensen;