By Ozzie Jurock
WHAT IS A REIT?
REITs are like those books that everybody quotes but nobody has read. So, let's just say that a Real Estate Investment Trust (REIT) is like a mutual fund that deals only in real estate investments. You put your money in a common pool with which properties are bought, sold and moved in and out by a fund manager. As an owner of shares in the REIT, you will get a proportional profit as share value appreciates.
Of course, you may have your proportional share of the losses. However, shares of publicly traded REITs remain attractive to investors because they can offer great yields and receive favorable tax treatment. Plus, REITs are required to pay 90% of their taxable income in dividends (after depreciation expense) They are RRSP and RRIF eligible investments and enjoy a level of liquidity that cannot be matched by owning the underlying investments outright.
SAVIORS OF THE INDUSTRY?
There are Mortgage REITs (they make their income by lending to borrowers to purchase real estate), and Equity REITs (like a landlord, they make money through rents). We at Jurock Real Estate Investor do not recommend these because they can carry huge loads of debt to finance deals and values fluctuate with interest rates.
The history of real estate oriented mutual funds and REITS is very checkered. In the mid-80's, REITs experienced huge losses when business properties in certain cities went over the 'cliff'. In 1992 to 1999, some of the trusts saw solid gains. However, in a financial environment where traditional leaders shy away from lending money to real estate developments, cash-challenged builders and developers are coming to regard REITs as saviors of the industry.
OPEN-ENDED VERSUS CLOSE-ENDED
The essential difference between a REIT and a real estate mutual fund or limited partnership is that mutual funds are open-ended. This means that the client/customer can make a request to redeem the value of the shares at any time regardless of the amount of the amount of money the account has on hand. In contrast, REITs are close-ended. They often invest in commercial or apartment block type properties. If x number of units are issued and traded on the stock exchange, they rise and fall with the market value of the properties in the trust. However, the REIT has no obligation to redeem the units. Just like any other stock market investment, the REIT holder sells it in the market for whatever it will bring.
THINGS TO REMEMBER WHEN CONSIDERING REITS:
1. Buy for dividend yields and participation in capital gains;
2. Diversify by property type and geographic location for a reliable income stream;
3. Look for staggered lease maturities and mortgage dates, and a stable tenant with potential for rent increases, redevelopment of properties, and future acquisitions;
4. Find out about the REIT's management track record;
5. Investigate liquidity;
6. For above-average return, invest during a period of low interest and mortgage rates, with rising rents and falling vacancy rates.
THREE INHERENT REIT RISKS:
1. In a fast rising market, many REITs overpay and rely too much on future
rent increases to make purchases pay off. The buildings owned by the trust may
not generate enough cash flow to carry them.
Result: a drop in income.
Consequence: shares fall in value.
2. If the stock market slips, in general, REITs slide down in tandem even if they have great assets.
3. In order to control the maximum assets, REITs usually invest in highly-leveraged
Result: high risk.
Consequence: the potential to lose a lot so check on debts carried by REITs.
Remember to look closely at the portfolio of your REIT and it's contents to see just what kind of things they do with the money. Look even more carefully at the management and/or the principals' previous performance. Be aware that many of today's REITs are yesterday's real estate mutual funds. Although they are dressed up in new clothes, they are dragging the tattered baggage of a very poor past performance.
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