Real Estate Investment Trusts (REITs), provide the benefits of investing in commercial property along with features of publicly traded stocks.
What are REITS?
Real Estate Investment Trusts (REITs) are companies that directly own, operate or finance income-producing property. They typically focus on commercial property (shopping malls, hotels, office blocks etc) rather than residential, they are tradeable on the stock exchange, and they pool investors’ cash in diversified holdings.
How do REITs work?
In general, for investments to be qualified as REITs a company must:
• Invest at least 75% of its assets in property.
• Earn at least 75% of profits from property rent, interest on mortgages or from property sales.
• Pay out at least 90% of taxable income as dividends to shareholders.
• Have no more than 50% of its shares held by 5 or fewer shareholders.
Benefits of REITs
1) Strong Return potential
Real Estate securities have historically outperformed broad equities and fixed income over the long term. As we can see from the chart below, returns from Real Estate has been better as these tend to have stable business models that attract long-term investment capital, while also offering the valuable inflation-fighting characterises of tangible asset.
Commercial property development objective is to have assets that produce a recurring stream of rental income and thus will also benefit from a favourable spread between their financing costs and cash flows generated. Overtime, Real Estate also tend to rise in value due to local infrastructure developments and tenant upgrades
2) Inflation hedged
The price of property is measured by the current cost of land, materials/labour required to build a replacement from scratch. As these costs tend to increase with inflation, Real estate is often viewed as a good store of value and hedge against inflation.
3) High dividend
Real estate securities tend to offer above-average dividend yields (typically higher than equities with similar risk), resulting from their cashflow oriented business and the requirement to distribute nearly all their taxable income.
Due to the inflationary nature of rents and property values, REITs have also a history of consistently raising dividends.
REITs provide a liquid vehicle for investing in real estate which is an illiquid investment. Whereas physical properties may take months/years to market or sell, REITs are traded daily on the exchange.
Like any other stock, listed real estate companies are subject to the scrutiny and regulations of public markets which is very important in the real estate market.
With REITs one can construct a global diversified Real Estate portfolio which in reality would have taken substantial capital commitment and time if this was done directly in physical property.
Furthermore, REITs are an important fact in portfolio construction due to their lack of correlation with traditional investment like equities and bonds. (see chart below).
7) Easy reach
Investing in property requires a large capital commitment. With REITS, you are allowed such benefits using very little amount of funds.
How can I invest in Real Estate?
One can of course invest in individual REITs and benefit from all that has been mentioned above.
Another way, which also provide efficient diversification is to invest in Global REITs ETFs. In this way your overall portfolio will contain different kind of REITs from across the globe thus optimising your risk/return trade-off.
An interesting ETF which I like is the iShares Developed Markets Property Yield UCITS ETF which is available in EUR and USD. This ETF has over 300 different underlying REITs from around the world and pays over 4% in dividend.
Would you like to know more investments which pay a high dividend? Find out more about our ‘High Income ETF’ portfolio which includes 15 different high dividend strategies