| What Are REITS (Real Estate Investment Trusts)?
Created in 1960 by the U.S. Congress, real estate investment trusts, or REITs, allow you to invest in property without the problems associated with owning actual bricks and mortar. It is a collective investment system in which investors money is pooled into a trust to invest in property shares in much the same way that a mutual fund invests in stocks.
REITs are involved with most types of property are commonly included, such as shopping malls, cinemas, industrial buildings and even prisons and golf courses! It is a good way of allowing you to get a return from property investment without worrying about individual rental income. The trust invests in buildings which are then leased and the profits go back into the trust; some investment trusts even finance the construction of real estate.
Most REITs are equity trusts that deal in hard property, and can be either publicly owned and traded on stock exchanges, or be private trusts. Around 10% are mortgage REITs that provide finance to purchasers and owners of real estate and acquire loans and securities backed by mortgages. Such trusts employ hedging strategies to protect against the risk of interest rate fluctuations, though such fluctuations can have positive as well as negative effects on the investment as a whole.
In the USA an investment fund specializing in real estate can get REITs status if it pays at least 90% of pre tax profits to the investors. This entitles it to avoid paying corporate tax on that part of the profit, thus eschewing the double taxation disincentive that most funds have. Corporate income tax can be avoided completely if it pays 100% of profits as dividends. Some real estate investment trusts do pay 100%, but while good news for the investor, this can curtail growth through a restriction in retained profits.
In fact the qualifying dividend was reduced in the USA in 2001 from 95% to 90% and even though this allows the provision for the retention of more capital for necessary expenditures such as maintenance of existing properties and refurbishment of property owned, it is still not an attractive investment for someone who is looking for growth. This can be offset in part through natural rises in property value and interest rate fluctuations.
REITs have steadily grown in popularity, particularly during periods of real estate booms. A large part of their popularity is that they do not correlate with other stocks and funds, and allow investors true diversification of their portfolios. The investor should be aware that, even though REITs are based on property, they are nevertheless shares that are traded on the stock exchange.
Probability statistics indicate that a drop in share prices is generally rapidly followed by an increase in property prices, and vice versa. So if the property market drops, then that is compensated by an increase in share prices. It is, therefore, a statistically good investment since it should remain fairly stable through periods of recession. There is a high reward for an acceptable risk of property deflation and this risk is further reduced when part of a diversified portfolio, of which REITs normally comprise up to 10%.
Dividends can be affected by slow cash flow growth and reduced occupancy and rental uptake, though they generally compare well with bonds. Depreciation is also factored into the calculation of profit, even though actual real estate prices can rise. All in all, however, real estate investment trusts can pay up to four times the dividend of an investment bond. This makes it a very attractive investment to anyone wanting a regular return as opposed to longer term growth.
In fact the National Association of Real Estate Investment Trusts (NAREIT) reported that the primary U.S. REIT index provided a return of over 34% in 2006, higher than any other equity benchmarks for seven years running.
In addition to the USA, real estate investment trusts are popular in Canada, Japan, France, Holland, Australia and have just been initiated in the UK where they are also called Property Investment Funds, or PIFs. Many other countries, are either operating their own trusts, or like Germany, are considering them. The time is rapidly approaching when this will be the main way that property intended for lease is financed.
If you have always wanted to own some real estate of value, but have been deterred by the risk associated with owning an individual piece of property, then real estate investment trusts are ideal for you. REITs are an investment phenomenon which is beginning to sweep the world, of which the only amazing feature is the time it has taken to happen.
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