People often turn to Real Estate Investment Trusts when they want to make some investments in property and real estate. It’s basically one of the investment types that people can make when they want to get some extra cash on the side.
But if you are thinking about having one, you should know how such investment works and how you can gain the best from it.
More about REITs
Real Estate Investment Trusts (or REITs) refers to a company; a business that creates, owns, and finance real estate that can generate income. It’s designed with mutual funds as the inspiration where investors can provide sources of income as the pool of capital.
Because of the model, individual investors are able to get dividends from their (real estate) investments, without them having to buy, finance, or manage the properties themselves.
There are several things to remember about REITs:
- It can generate a steady income for the investors, but it doesn’t offer much in capital appreciation way
- Most REITs are designed to be publicly traded (such as stocks), which make them extremely liquid
- REITs invest in various real estate (property) types, covering data centers, apartment buildings, retail centers, cell towers, medical facilities, offices, hotels, and warehouses.
How REITs Work
Real Estate Investment Trusts basically has a pretty straightforward and direct business model. REIT would lease space and then collects the rents. The rents would then be distributed as dividends to the shareholders.
Mortgage REITs may not own real estate, but such a business finance the real estate. They get their income from the interest.
By IRS regulation and by law, REITs must pay 90% of its taxable profits as dividends to their shareholders. That’s why most REIT companies would be exempted from most (corporate) income tax. In the meanwhile, REIT shareholders (who get the dividends) must pay the tax as they are viewed as the ordinary dividends.
Different REITs Types
On the contrary to what people believe, there are basically different kinds of REITs out there.
· Equity REITs. This is what most REITs are created as. This kind of business owns and manages real estate that can produce income. The properties are able to generate revenues through rents, not through re-sales.
· Mortgage REITs. This kind of business would lend money to (real estate) operators and owners. They lend the money indirectly (via acquisition of the mortgage backed securities) or directly (through loans and mortgages). Their income is made especially from the interest margin (the spread from the cost of loan funding and the earned interested on the mortgage loan). This kind of model would be sensitive to (interest) rate increase or decrease
· Hybrid REITs. This model uses investment strategies that combine both mortgage and equity REITs.
Tips in Choosing a REIT
There are several REIT companies out there, so how do you know which Real Estate Investment Trusts would be the right one for you? The first thing you should do is to do your ‘homework’. To make it easier, there are several obvious signs that you should be aware of.
- Sound Management
You should always look into the company’s track record and past histories. Don’t forget to look into the managers’ track record too.
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The ability of the manager is closely related to asset appreciation and profitability. They would be the one that can choose the right investment and decide on the best strategies to develop. Check how they are financially treated or compensated. If it’s determined by performance, they would likely do their best.
- The General Earnings
You should look into cash availability (for distribution) and also funds for the operations. They are crucial for REIT’s overall performance because you can see the REIT’s overall performance – showing the amount of money transferred to the investors.
However, you shouldn’t use the generated numbers because they still incorporate the depreciation value of the property. The numbers will change afterwards. You should also keep in mind that the REIT returns may be anomalous because of the ‘luck’ factor in choosing the right investment and also the market condition of the real estate.
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- The Diversification
REITS focuses on property’s ownership. You need to know that the (real estate) markets fluctuate by property type and location. That’s why you choose REIT with proper diversification scheme.
If REIT is focusing on commercial real estate only and there is a significant reduction in occupancy rates, then you will encounter issues. Through diversification, you can also know that the business has enough access to the capital to finance the future growth initiatives as well as leveraging itself properly, for the sake of increased returns.
Be aware of REIT fraud. SEC (Securities and Exchange Commission) advises investors to only buy REITs registered with SEC. They have a search tool, which is free, that enables you to search for an investment professional that is registered and licensed.
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You can learn about other types of real estate investments, including wholesaling or flipping houses, besides the available Real Estate Investment Trusts.