Real estate investment trusts (REITs) are companies that own and most often actively manage income generating commercial real estate. Some REITs make or invest in loans and other obligations that secured by real estate collateral. Most REITs are publicly traded. The U.S Congress created the legislative framework for REITs in 1960 to enable the investing public benefit from investments in large scale real estate enterprises. REITs, now commonly referred to as real estate stocks, have much to offer the institutional and retail investing communities. They providing ongoing dividend income along with the potential for long term capital gains through share price appreciation, and can also serve as a powerful tool for portfolio balancing and diversification.
The ownership of REIT shares has historically increased investors total return and /or lowered the overall risk in both equity and fixed income portfolios. Dividend growth rates for REIT shares have outpaced inflation over the last decade. The REIT business model is based in great part on the value of tangible and quantifiable assets, namely large scale commercial real estate. This characteristic is untrue of many other industries. Individual investors can choose to more broadly benefit from the opportunities in the REIT market by investing in a “pure-play” REIT mutual fund. These mutual funds are run by portfolio managers with a high degree of expertise in the real estate industry. these investment vehicles are similar to other sector specific funds such as retailing, pharmaceuticals, transportation, financial services, energy, defense, etc.
History of REIT
The origins of REIT date back to the 1880s. at the time, investors could avoid double taxation because trusts were not taxed at the corporate level if income was distributed to beneficiaries. This tax advantage, however, was reversed in the 1930s, and all passive investments were taxed first at the corporate level and later taxed as a a part of individual incomes. Unlike stock and bond investments companies, REITs were unable to secure legislation to overturn the 1930 decision until 30 years later. Following world war 2, the demand for real estate funds skyrocketed and President Eisenhower signed the 1960 real estate investment trust tax provision which reestablished the special tax considerations qualifying REITs as pass through entities (thus eliminating the double taxation). This law has remained relatively intact with minor improvements since its inception.
REIT investment increased throughout the 1980s with the elimination of the certain real estate tax shelters. Investments in real estate provided investors with income and appreciation. The tax reform Act of 1986 allowed REITs to manage their properties directly, and in 1933 REIT investment barriers to pension funds were eliminated. This trend of reforms continued to increase the interest in value of REIT investment.
Today, there are more than 200 publicly traded REITs operating in the united states and alone their assets total over $500 billion. Approximately two-thirds of these trade on the national stock exchanges.
In order for a corporation to qualify as a REIT and gain the advantages of being a pass through entity free from taxation at the corporate level, it must comply with the following Internal Revenue Code Provisions (USA):
Structured as corporation, business trust, or similar association
Managed by a board of directors or trustees
Shares need to be fully transferable
Minimum of 100 shareholders
Pays dividends of at least 90% of REIT taxable income
No more than 50% of the shares can be held by five or fewer individuals during the last half of each taxable year
At least 75% of total investment assets must be in real estate
Derive at least 75% of gross income from rents or mortgage interest
Have no more than 20% of its assets consist of stocks in taxable REIT subsidiaries
REITs similarity with other business
More than ever, REITs are vital public companies that share a multitude of similarities with other mainstream business:
Investors can purchase shares in REITs as easily as they purchase shares in anyother publicly traded company. REIT shares are traded on all of the major stock exchanges in the U.S., including the New York Stock exchange (NYSE), NASDAQ, and American Stock Exchange (AMEX), as well as various after-hours markets.
Just like investors in other public companies, REIT shareholders receive value in the form of both dividend income and share value appreciation.
Active Management / Corporate Governance
Publicly-traded REITs generally are actively and professionally managed corporations. They adhere to the same corporate governance principles that apply to all major companies. they have a senior management team that is headed by a chief executive officer (CEO) who actively manages the overall strategic vision and equity of the enterprise. The Board of Directors appoints the CEO, which in turn is elected by and accountable to the shareholders of the REIT.
REITs, like other public companies in the U.S. , are required to make regular financial disclosures to the investment community, including quarterly and yearly audited financial results with concomitant filings to the securities and exchange commission.
As is the case with investments in other publicly traded companies, shareholders have no personal liability for debts of the REITs in which they invest.
One reason so many REITs (65% based on equity market capitalization) are rated investment grade is their moderate financial leverage. In fact, the average REIT debt ratio has generally been below 50% for much of the last decade.
Returns delivered by REIT
REITs Deliver Income & Long-term Growth
The special investment characteristics of income producing real estate provide REIT investors with competitive long-term rates of return that complement the returns from other stocks and bonds.
High Dividend Yield
REITs are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends. Significantly higher than other equities on average, the industry’s dividend yields generally produce a steady stream of income through all market conditions.
Share Price Appreciation
Approximately one-third of the total return from REIT stocks over the last 20 years came from moderate, long-term growth in share prices. This growth generally has tracked the consumer price Index over the last two decades, protecting shareholders capital from the ravages of inflation.
Advantages of Real Estate Investment:
In addition to the benefits of owing shares in a REIT, offer several advantages not found in companies across other industries. These benefits are part of the reason that real estate stocks have become popular investment vehicles over the past several years:
Predictable Revenue Stream
REITs’ reliable income is derived from rents paid to the owners of commercial properties whose tenants often sign leases for long periods of time or interest from the financing of those properties. In addition, the companies ownership of tangible assets with established values tends to reduce risk.
Most REITs operate along a straightforward and easily understandable business model: By increasing rents or occupancy rates, higher levels of income may be generated. When reporting financial results, REITs, like other public companies, must report earnings per share on the basis of GAAP net income. Another way year-to-year financial progress can be gauged is by comparing levels of funds from operations (FFO). FFO, the industry’s supplemental performance measure, differs mainly from net income by excluding depreciation and amortization of real estate assets and gains and loses from most property sales. Given the broad range of real estate subsectors and business lines, there are also a number of additional earnings metrics, which are used by REITs in order to provide investors with a greater level of insight into their performance.
The combination of income returns from dividend and capital gains from share value appreciation can result in healthy overall returns for REIT investors. Analysis by Ibbotson Associates demonstrates that the combination of dividend yield and share value appreciation has made REIT returns competitive with other major investments vehicles, including a broad range of large-cap stocks, small-cap stocks and fixed income securities. In short, REITs over time have demonstrated a historical track record of providing a high level of current income combined with long-term share value appreciation, inflation protection, and prudent diversification for investors across the age and investment style spectrums.
With a very diverse profile, the REIT industry offers investors many alternatives across a broad range of specific real estate subsectors, including:
Shopping centers and malls
Industrial parks and warehouses
Lodging facilities, including hotels, motels and resorts
Health care facilities
Regardless of specific business line, REITs most often acquire and develop their properties primarily to actively manage and operate them as income producing, ongoing businesses, while regularly exploring new opportunities for income growth, from new acquisitions or development, to provide income-producing leasing or tenant services. In addition, REITs that have a mortgage focused investment strategy invest in commercial mortgages (CMBS) and residential mortgages (MBS).