Real Estate Investment Trusts-REITs-What Are They? - vrk100- 20Jun2006

Real Estate Investment Trusts-REITs

What Are They?

 (Update 27Sep2021 and update 08Feb2021 on REITs are available)

 

 

(This article was originally written on June 20th, 2006 but uploaded on this blog only on December 31st, 2009)

 

Brief Introduction of REITs

 

Real Estate Investment Trusts (REITs) are a new concept in India. REITs (pronounced ‘reets’) are companies that own and collect rent from commercial and residential properties. The income from operations is distributed to the shareholders. A REIT is a company that owns, and in most cases, operates income-producing real estate such as apartments, shopping centers, offices, hotels and warehouses. 

 

Some REITs also engage in financing real estate. The shares of many REITs are freely traded, usually on a major stock exchange. REIT shares represent ownership in an operating business. But a REIT has two unique features: its primary business is managing groups of income-producing properties and it must distribute most of its profits as dividends.

REITs allow investors to pool their investments in real estate, as is the case with a mutual fund, in order to get the same benefits as might be obtained by direct ownership, while also diversifying their risks and obtaining professional management.

REITs were created in 1960 in the USA to make investments in large-scale, income-producing real estate accessible to investors. They offer investors high yields, as well as a highly liquid method of investing in real estate.  In the USA, REITs receive special tax considerations. REITs do a decent job of combating inflation. 

 

They may not be a 100 per cent foolproof against inflation, but are a good defence against the erosion of purchasing power without hampering overall return. The case for investing in a REIT is weaker-from a diversification point of view-if one owns a home, since that gives them an inherent stake in real estate ownership.

 

 

There are several kinds of REITs:

  
1. Equity REITs: Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets), like apartments, warehouses, shopping malls, office buildings or hotels. Their revenues come mainly from their properties' rents.

2. Mortgage REITs: Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans. 

  
3. Hybrid REITs: Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.

Investors can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. An additional benefit to investing in REITs is the fact that many are accompanied by dividend reinvestment plans (DRIPs). 

 

Benefits of REITs:

1. Diversification: Investors get the benefit of diversification by investing in REITs

    

2. Dividend: One of the most attractive features of investing in REITs is that REITs must pay a major share of their taxable income to shareholders in the form of dividends each year

3. Capital appreciation: REITs are total return investments that typically provide high dividends plus the potential for moderate, long-term capital appreciation. Long-term total returns of REIT stocks are likely to be somewhat less than the returns of high-growth stocks and somewhat more than the returns of bonds. 

Real estate funds globally have a huge potential market and India being a growing domestic market, real estate funds are the new route for investments. Investors may soon get an opportunity to invest in real estate mutual funds. SEBI is likely to announce guidelines for real estate mutual funds next week. The guidelines may probably allow mutual fund schemes to invest in real estate projects and real estate specific funds.

 

Problems with REITs:

However, some experts perceive certain problems for REITs in India. The problems cited by them are:

1. Non-existence of an exchange, proper regulations

2. Poor price discovery

3. Settlement and liquidity problem

4. Valuation of physical assets is problematic

They say the funds need to be diversified geographically, in different projects as well as in different developers. Valuations are to be done at least quarterly. They need to be close-ended funds essentially as real estate is not liquid and heavy exit load need to be charged so that people stay put in their investments.

 

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Sources: Newspapers, Magazines, Investment books, web sites, etc.

 

 

Disclosure:  I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets. 

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