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Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) allow individual investors to invest in large-scale, income-producing real estate. REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership - without actually having to go out and buy commercial real estate.

What is a REIT?

A REIT, generally, is a company, trust or association that owns (and sometimes operates) income producing real estate or real estate related assets. The income producing real assets owned by a REIT may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortagages or loans. Most REITs specialize in a single type of real estate - for example, apartment communities. There are retail REITs, office REITs, residential REITs, healthcare REITs, and industrial REITs, to name a few. The distinguishing feature of REITs from other assets is that REIT must acquire and develop its real estate properties primarily to operate them as part of its own investment portfolio, as opposed to reselling those properties after they have been developed (like real estate developers).

Categories of REITs

There are three categories of REITs as follows.

1. Equity REITs
2. Mortgage REITs
3. Hybrid REITs

Equity REITs
Equity REITs typically own and operate income-producing real estate. Most REITs are equity REITs.

Mortgage REITs
Mortgage REITs provide money to real estate owners and operators either directly in the form of mortgages or other types of real estate loans, or indirectly through the acquisition of mortgage-backed securities. They tend to be more leveraged (that is, they use a lot of borrowerd capital) than equity REITs. In addition, many mortgage REITs manage their interest rate and cret risks through the use of derivatives and other hedging techniques. In many cases, mortgage REITs provide the same exposure as a real-estate focussed mutual fund.

Hybrid REITs
Hybrid REITS are companies that use the investment strategies of both equity REITs and mortgage REITs.

Publicly traded REITs and Non-pubicly traded REITs

Many REITs are publicly traded on stock exchanges, while there are equally many that are not publicly traded; they may be traded privately in the OTC market. The below table provides a comparison of these two.

Criteria	Publicly traded REITs	Non-Traded REITs
Overview	These are registered REITS and are traded on national stock exchanges.	These are also registered REITS but are not traded on stock exchanges. They may be traded privately in OTC market.
Liquidity	There is sufficient liquidity in general in these REITs. Liquidity may also depend on the category of REIT and the strength of the issuer and the assets.	Liquidity may not be there. There could be redemption programs for these REITs. Investors have to wait to receive a return of their capital until the company decides to engage in a transaction such as the listing of the shares on an exchange or a liquidation of the company's assets.
Transaction Costs	Brokerage costs apply as these are traded on stock exchanges that are represented by brokers and/or dealers.	There could be some fees charged by the broker-dealers for providing liquidity in OTC market, or there could be pre-closure charges in case the REIT has provision for early redemption (partial or full redemption).
Management	The managers are employees of the company	Typically, the company has no employees and is managed by a third party pursuant to a management contract.
Minimum investment	In general, the minimum investment is one share (whatever the cost of that one share is).	The minimum investment might be slightly higher than the traded REITs. These types of REITs are usually issued to institutional investors and hence the minimum investment amount tends to be higher.
Independent Director	The rules of the regulators and stock exchange governing independent directors apply to REITs. These are similar to ETFs and stocks.	The rules of the regulator apply to REITs
Investor Control	Investors elect directors	Investors elect directors
Share value transparency	Real-time market prices are publicly available. Wide range of analyst reports are also available to the public.	Information may not be publicly available.
Front-end fees	Front-end underwriting fees in the form of a discount may be 7% or more of the offering proceedings. If investors buy these REITs in the open market then they will have to pay a brokerage commission also.	Front-end fees can be as much as 15% of the share price. These include selling commissions and other expenses.
Anticipated source of return	Investors typically seek capital appreciation based on prices at which REITs' shares trade on an exchange. These REITs may pay dividends to shareholders.	Investors typically seek income from distributions over a period of years. Upon liquidation, return of capital may be more or less than the original investment depending on the value of the asset.

Valuation Methods and Disclosures

For traded REITs, the value of the REITs share depends on the demand and supply on the stock exchange on which it is listed.

For non-traded REITs, broker-dealers involved in the sale of non-traded REITs are required to provide investors with a per-share estimated value of the REIT, generally, using one of the following two methodologies.

Net Investment Methodology
When this method is used, the firm must disclose to the investors whether part of the distribution from the REIT includes a return of capital, which reduces the estimated per share value.

Appraised Value Method
This valuation method can be used at any time. It involves a valuation conducted by the firm with or without the help of a third-party expert or a service provider. The method involves valuation of all assets and liabilities of the REITs.

Complexities and Risks involved with public non-traded REITs

When it comes to investing in non-traded REITs, selling points such as the opportunity for capital appreciation, diversification and the allure of a robust distribution can be enticing. But investors should balance these selling points against the numerous complexities and risks these investments carry. The following points should be kept in mind.

Distributions are not guaranteed and may exceed operating cash flow
Deciding whether to pay distributions and the amount of any distribution is within discretion of a REITs Board of Directors in the exercise of its fiduciary duties. Distributions can be suspended for a period of time or halted altogether. Many factors influence the composition of these payments. For example, in newer programs, distributions may be funded in part or entirely by cash from investors capital or borrowing - leveraged money that does not come from income generated by the real estate itself, such as rents or hotel occupancy fees. The REITs articles of incorporation often allow it to increase debt, dip into cash reserves and apply proceeds of the sale of new shares to sustain or even increase distributions. Some REITs even allow borrowing in excess of 100 percent of net assets. Leveraging, including the use of borrowed funds to pay distributions, can place the REIT at greater risk of default and devaluation, which can result in investment losses when it comes time to redeem or liquidate shares, as well as a reduction in, or suspension of, distributions.

Distributions and REIT status carry tax consequences
Distributions for all REITs that are from current or accumulated earnings and profits are taxed as ordinary income, as opposed to the tax rate on qualified dividends, which generally carry a tax rebate.

Lack of public trading market creates illiquidity and valuation complexities
As their name implies, non-traded REITs have no public trading market. However, most non-traded REITs are structured as a "finite-life investment", meaning that at the end of a given timeframe, the REIT is required either to list on a national stock exchange or liquidate. Even if a liqudity event takes place, there is no guarantee that the value of the investments will have gone up - and it may go down or lose all its value. Indeed, valuation of non-traded REITs is complex. Many factors affect the pricing, including the portfolio of real estate assets owned, strength of the trust's balance sheet (assets versus liabilities), overhead expenses, cost of capital and more. The boards and managers of non-traded REITs might even rely on third-party sources to estimate a per-share value.

Early redemption is often restrictive and may be expensive
Most public non-traded REIT offerings place limits on the amount of shares that can be redeemed prior to liquidation. Redemption provisions can be as restrictive as 5 or even 3 percent of the weighted average number of shares outstanding during the previous year. In addition, shares may have to be held for some period, typically one year, before they can be redeemed. Redemption programs may be terminated or adjusted, so investors should not count on them, even as an emergency exit strategy. While a redemption program may allow you to sell your shares prior to a liquidity event, the redemption price is generally lower than the purchase price, sometimes by as much as 10 percent.

Fees can add up
Non-traded REITs can be expensive. Front-end fees generally come in two parts:

1. Selling compensation and expenses, which cannot exceed 10 percent of the investment amount; and
2. Additional offering and organisational costs, sometimes referred to as "issuer costs" which are also paid from the offering proceeds.

Properties may not be specified
Most non-traded REITs start out as blind pools, which have not yet specified the properties to be purchased. Others may specify a portion of the properties the REIT plans to acquire, or they may be in various stages of acquisition. In general, the more properties they have been specified for purchase or that have actually been acquired the less risk an investor incurs because the investor has the opportunity to access the nature and quality of the asset of the REIT before investing.

Diversification can be limited
While REITs as an investment class may help diversify a portfolio, putting all the intended real estate investment in one REIT - including investment in different issuances or phases of the same REIT - can exposure an investor to the risk of underdiversification.

Real Estate Risk
There are risks associated with both the real estate market as a whole and any specific subset of the real estate market on which a particular REIT concentrates.

Types of REIT investments

1. Speciality
2. Data Centers
3. Infrastructure
4. Timber
5. Health Care
6. Self Storage
7. Lodging / Resorts
8. Diversified
9. Residential
10. Retail
11. Industrial
12. Office

Glossary of terms used in REITs

REIT Name: Full name of the company.

Ticker:The company's stock exchange symbol.

Share Price ($): The closing price per share on the date notified.

52-Week Share Price ($): The high and low closing prices for the shares over the previous 52 weeks.

Dividend Yield (%): The current indicated dividend rate annualized and divided by the current stock price.

Dividend Spread (%): The difference between the REIT dividend yield and the 10-year constant maturity treasury yield.

Total Returns: The total returns are calculated by taking the closing price for the current period, adding any dividends with an ex-dividend date in that period then substracting the closing price for the previous period and dividing the result by the closing price of the prior period.

Debt Ratio (%): A leverage ratio calculated by taking the REIT's total debt and dividing it by the total market capitalization. Total capitalization is the sum of implied market capitalization and total debt.

Long-Term Issuer Rating: The long-term credit rating, as announced by rating agencies.

Average Share Volume: The average number of shares traded daily over the past month.

Average Daily Dollar Value: The average of the daily value of shares traded over of the past month. Daily value is computed by multiplying shares traded by the closing price on that date.

Relative Liquidity (%): Average daily dollar volume divided by equity market capitalization.

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