A Real Estate Investment Trust (REIT) is a special type of company that invests in various sectors of the real estate industry. Some of these sub-sectors are hospitality, mortgage, farmland, prisons, retail, and office industries.
Most REITs are publicly-traded companies, meaning that they are accessible to all types of investors. In this article, we will look at what REITs are, why invest in them, and some of the key terminologies you need to know.
REIT vs. other companies
While REITs are similar to other companies, there are some key differences. For example, a conventional company, say Microsoft, can do any type of business because there are no limitations. For REITs, this is different. By law, these companies can only generate 75% of their revenue from real estate, property, or land.
Second, regular companies like Apple can do whatever they want with their revenue. They can invest it, save it, or distribute it to their shareholders through dividends and buybacks. For REITs, according to the law, they must return 90% of their income to shareholders every year. While this tends to be good for shareholders, it also limits them on what they can do with their funds.
Third, a REIT must have a minimum of 100 shareholders and be taxed as a corporation. There are no limits to the number of shareholders that regular companies should have.
Therefore, if REITs have all these limitations, why do companies follow this path? The answer is that these companies tend to pay a lower tax rate than other firms. At the same time, investors love them for the generous dividends they pay every year. Indeed, historically, REITs have a higher dividend yield than other firms.
As an investor, you are basically focused on how a company or sector performs in the market. In the past few years, REITs have not performed well. Indeed, in 2020, amid the coronavirus pandemic, REITs were among the worst performers.
That’s because some of the sub-sectors like retail and offices went through significant challenges as many retailers went bankrupt and as more people stayed at home. Office REITs have suffered as most companies embrace the work-from-home model.
REITs have also performed poorly because of the overall shift from value and dividend investing to growth stocks. In the past few years, most investors have embraced companies like Apple, Microsoft, and AMD that promise excellent returns.
A good approach to view the recent performance of REITs is to look at how the SPDR REITs ETF has performed against the S&P 500. As shown below, the REITs ETF has greatly underperformed the S&P 500 in the past five years.
REITs ETF vs. S&P 500 five-year performance
Top REITs investing terms
While REITs are similar to other companies, there are several terminologies that investors need to understand. Doing so will help you do your research well about the industry. Some of the most important terms you need to understand are:
- Funds from Operations (FFO). These refer to a company’s net income minus losses or profits from sales of property and adding depreciation. It is the best measure of identifying a REITs performance.
- Adjusted FFO REITs prefer using the AFFO because it excludes funds used to improve the property.
- Hybrid REIT. As I will mention below, there are several types of REITs. Therefore, a hybrid REIT is one that combines two or more of these REITs.
- Mortgage REIT. Also known as a REIT, this is a trust that creates or owns loans that are collateralized by mortgages.
- Straight-lining. This is a process in which a company averages the total rent owned by a company over time.
Other REIT-related terms you need to know are UpREIT and DownREIT, Securitization, and Positive Spread Investing (PSI), among others.
Types and examples of REITs
As mentioned above, there are many types of REITs that you can invest in. Indeed, there are more than 1,000 REITs in the United States that manage more than $3.5 trillion in assets. Some examples of these REITs are:
- Office REITs. These companies own office buildings that are used by most businesses in the US. Indeed, companies like Google and Procter & Gamble operate mostly from buildings owned by REITs. They generate revenue from rents paid by these companies. They include SL Green and Boston Properties.
- Retail REITs. These firms own shopping centers and malls that they then lease to retailers like Macy’s and Nordstrom. They include Simon Property Group and Kimco Realty.
- Hospitality REITs. If you have visited a hotel recently, the chances are that the hotel company does not own the building. Instead, they sign lease agreements with REIT companies like Apple Hospitality and Ryman Hospitality Properties, among others.
- Farmland REITs. These companies own a vast amount of farmland and forests in the United States and abroad. They mostly make money by leasing the land or selling timber. They include Gladstone Land and Farmland Partners, among others.
- Prison REITs. These companies serve the local and federal government by providing prison services. Examples are CoreCivic and GEO Group.
- Data Centre REITs. Companies like Amazon and Microsoft are large in cloud computing and own thousands of servers globally. To achieve that, they partner with data center REITS like Equinix and Digital Realty that provide the storage.
There are other types of REITS, which include mortgage REITs, apartment REITs, health care, public storage, and infrastructure REITs, among others.
How to Invest in REITs
There are three key steps you need to follow when investing in REITs. First, you need to identify these companies. You can use a free screener like the one provided by Yahoo Finance and Barcharts to find these REITs.
Second, if you are investing for the long-term, you need to do more research into them. Look at their past performance and the sector they are in. For example, investing in retail REITs at a time when the retail sector is dying might not be a good idea. Finally, have an account with a broker like Robinhood, Schwab, and TD Ameritrade and buy the stock.