The Wall Street Journal reported that Real Estate Investment Trust (REIT) owned some 50,000 condominiums in 1991 and that by the end of 1996 ownership of condominiums had risen to over 600,000 units. It is estimated that they had purchased a further 180,000 by the end of 1997. Stock market investors looking for (some) diversification are returning to the REIT investments with a vengeance. But, what is a REIT?

REITs are like those books that everybody quotes but nobody has read. When the talk turns to real estate, people talk about REITs, bandy the term about but if you asked for a definition, most people would be hard pressed to get it right. So first of all, what it a REIT? A REIT is a Real Estate Investment Trust.

Well what does that mean? Here are a few answers:

Without going into exhaustive detail and trying to teach you everything about real estate securities in one little article let's just say that REITs are sort of like a mutual fund that deals only in real-estate investments. You put your money into a common pool; then properties are bought and sold and moved in and out of the fund. You invest in a REIT because you believe that the clever folks overseeing the REIT will make money as they carry on this activity of buying and selling. You, as an owner of shares in the REIT will get your proportional share of the profits as your share value appreciates.

That's the way it's supposed to work. If things go against you then you have your proportional share of the losses. A REIT is a microcosm of real life. And as you know, sometimes life is real and life is earnest.

Cash challenged builders and developers are becoming increasingly fond of REITs. In a financial environment where traditional lenders such as banks and insurance companies shy away from lending money to real estate developments (Can you say, 'Canary Wharf, London, England'?) developers are coming to regard the REITs as saviors of the industry.

But the investors in some of those REITs may hold a different view --- and for good reason. If you took an overview of the history of real estate oriented mutual funds and REITs you would find that history to be very checkered. The pavement of Wall Street and the equivalent street in any of the other financial centers of the world are littered with the bones of investors who bought into the story that certain REITs were telling. You have to color that whole picture painful.

In the mid-1980's, REITs experienced huge losses when business properties in certain cities went over the cliff. In 1992/97 some of the trusts saw solid gains. But it can also be a roller coaster. Be careful.

It is important to be aware of the essential difference between a REIT and a real estate mutual fund or limited partnership. Real estate mutual funds are 'open-ended. This means that the client/customer can require them to redeem the value of the shares at any time. That means that whether or not the fund has the money on hand or not, if redemption is requested the fund has to comply. The result of this is that when markets cool, investors want out, and the fund finds itself carrying a heavy redemption load.

Where do they get the money? They sell some property into an often already depressed market which, of course, pushes the market even lower. The end result is a sort of dreadful snowball. The fund sells to meet obligations, the resulting drop panics some more investors, they come running to the fund waving their rapidly devaluing paper --- no fun for anyone

REITs on the other hand are not open ended. They are 'closed-ended: X number of units are issued and traded on the stock exchange. Sure, they rise and fall depending on what's happening in the marketplace with the value of the properties in the trust but 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 and that's that. If it's doing well and therefore beloved then it will rise in value. If it's not doing well then the opposite will occur --- just like real life.

Most of the time your REIT will be investing in commercial or apartment block type properties. The newest 1998 fad is investing in hotels. Here are some of the major inherent risks:

1. 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. Like mountaineers on the same rope, when the market slips the REITs fall even if they have great assets.
   
   
3. In order to control the maximum assets REITs usually invest in highly- leveraged properties. Translation: High risk with the potential to lose a lot. (Sort of like Las Vegas except nobody buys you free drinks)

If you're thinking of investing in a REIT take a very careful look at it. Look closely at the portfolio of your REIT 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.

(Many of today's REITs are yesterdays real estate mutual funds. Although they are dressed up in new clothes they are dragging the tattered baggage of a very poor past performance.) And check out what's actually in the portfolio. ' Potential buys' are just so much fluff. You want to see the actual meat and what you don't want is to get involved with a bunch of magic has-beens.

jurock.com

About the Writer
Ozzie Jurock is the president of Jurock Publishing Ltd., Editor of Real Estate Insider Publication and Author of Forget Location

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