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REAL ESTATE INVESTMENT TRUST
What is a REIT?
A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends.
REITs allow anyone to invest in portfolios of large-scale properties the same way they invest in other industries – through the purchase of stock. In the same way shareholders benefit by owning stocks in other corporations, the stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy or finance property.
Most REITs are traded on major stock exchanges, but there are also public non-listed and private REITs. The two main types of REITs are Equity REITs and Mortgage REITs. Equity REITs generate income through the collection of rent on, and from sales of, the properties they own for the long-term. Mortgage REITs invest in mortgages or mortgage securities tied to commercial and/or residential properties.
Today, REITs are tied to almost all aspects of the economy, including apartments, hospitals, hotels, industrial facilities, infrastructure, nursing homes, offices, shopping malls, storage centers, student housing, and timberlands. REIT-owned properties are located in every state and support one million U.S. jobs annually. U.S. REITs have become a model for REITs around the world, and now more than 30 countries around the world have adopted REIT legislation.
Brief History of REITS
September 14, 2010 marked the beginning of the 50th anniversary year of celebration of the U.S. REIT industry. Fifty years prior, President Dwight D. Eisenhower signed legislation that created a new approach to income-producing real estate investment , a manner in which the best attributes of real estate and stock-based investment are combined.
REITs, for the first time, brought the benefits of commercial real estate investment to all investors , benefits that previously had been available only through large financial organizations, intermediaries and to wealthy individuals.
Over time, investors responded to this new opportunity, and 50 years after their creation stock exchange-listed U.S. REITs constituted a more than $300 billion equity market with an average daily trading volume of about $4 billion. Public, non-listed REITs in the U.S. now manage assets of more than $70 billion and are adding another $7 billion annually. Outside the U.S., REITs and listed property companies constitute another $700 billion plus, comprising a listed REIT and real estate investment universe of more than $1 trillion.
REITs in the U.S. and increasingly around the world now regularly provide investors with meaningful dividends, portfolio diversification, valuable liquidity, enviable transparency and competitive performance.
Investors who diversify their portfolios have a better chance of ending up with more savings for their retirement and other financial goals. In part this is because diversification reduces the risk of volatility and losses from any one security or asset class. In other words, don’t put all your eggs in one basket.
Real estate is considered a distinct and essential asset class that every investor should own as part of a well-diversified portfolio. Decades of portfolio research show REITs have a low-to-moderate correlation with other sectors of the stock market, as well as bonds and other assets.
A key benefit of diversification is the potential to increase long-term returns without taking on additional risk. The chart below illustrates how taking a portfolio made up of 60% stocks and 40% bonds and reallocating 10% to listed U.S. REITs would have improved annual returns by 0.25% per year on average over the 25 years from 1990 to 2014, while reducing portfolio volatility by 0.21% per year. For a portfolio with a beginning value of $10,000, that would have added $4,369 of additional gains while exposing the investor to less portfolio risk.
Stock exchange traded equity REITs have proven to be the best sector of the stock market for diversification. This is because REITs historically have not moved closely in tandem with other sectors of the broader stock market, particularly for investors whose time horizons are measured in years rather than months.
REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.
A practical way of measuring the inflation protection provided by REITs is to directly compare REIT dividend growth with inflation. In all but two of the last 20 years, REITs’ dividend increases have outpaced inflation as measured by the Consumer Price Index.
Other assets such as commodities and Treasury inflation-protected securities (TIPS) can also provide good inflation protection. Even stocks can be an important part in a portfolio that protects investors against inflation shocks.
Stock exchange traded U.S. REITs give investors access to income-producing real estate combined with the transparency of public markets.
REITs must disclose financial information to investors and report on material business developments and risks. This transparency enables investors to analyze and value REIT assets independently. The financial markets put a value on the stock prices of REIT companies on a real-time basis as investors analyze and make investment decisions based on their evaluation of future prospects.
Stock exchange-listed REITs are held to the same standards and requirements as other publicly traded companies. Listed REIT reporting is governed by the Securities & Exchange Commission, Generally Accepted Accounting Principles, and the various stock exchanges on which their shares trade.
Listed Equity REITs also report Funds from Operations (FFO) as a supplemental earnings measure in their financial statements. FFO is considered by many to be the most reliable metric by which to value property-owning real estate companies, and provides a good indication of the dividend-paying capacity of REITs.
REITs give all Americans the opportunity to invest in income-producing real estate without owning the actual properties. REITs in the U.S. and many other parts of the world now make real estate investing easy and efficient, thanks to the liquidity of public markets.
The equities of companies that own portfolios of properties or engage in real estate financing are bought and sold on major U.S. stock exchanges every day. There are more than 200 REITs traded on U.S. stock exchanges and held by REIT mutual funds and ETFs, with a market capitalization approaching $1 trillion at the start of 2015. Globally, there are more than 200 REITs from 30 countries outside of the U.S., which are transforming how people invest in real estate opportunities around the world.
As a result of public market liquidity, REITs make real estate investing efficient and accessible for individuals. For many, REITs also provide considerably less hassle and risk than buying, managing and maintaining their own building. REITs also provide an effective way for professional investment managers to manage their real estate investments; and a meaningful way to reduce the risks of illiquidity.
When people think of REITs, they think “dividends.” REITs are well suited to income investors, due to their strong and reliable dividend payouts that have tended to increase over time.
Equity REITs own and typically manage properties and generate income by collecting rent from tenants, while mortgage REITs make money by financing income-producing real estate. Because REITs must pass almost all their taxable income to shareholders as dividends under U.S. law, the reliable income streams from real estate have been one of the chief drivers of REIT industry performance.
The high dividend payout requirement means a larger share of REIT investment returns come from dividends when compared with other stocks. REIT dividend yields have historically been a good deal higher than the average yield of the S&P 500 Index. In fact, over the long-term, about half of REIT total returns have come from dividends, compared to less than one-fourth for the S&P 500.
For long-term retirement savings, dividends do make a difference. For investors with a longer time horizon, dividends can be reinvested to generate future returns, while in later years they can provide a steady income stream to help meet expenses in retirement.
REITs’ track record of reliable and growing dividends, combined with long-term capital appreciation through stock price increases, has provided investors with attractive total return performance for many periods over the past 40 years compared to the broader stock market as well as bonds and other assets.
REITs are professionally managed, publicly traded companies that manage their businesses with the goal of maximizing shareholder value. That means positioning their properties to attract tenants and earn rental income, and managing their property portfolios and buying and selling of assets to build value throughout long-term real estate cycles.
This drives total return performance for REIT investors, who benefit from a strong, reliable annual dividend payout and the potential for long-term capital appreciation. For example, REIT total return performance over the past twenty years has outstripped the performance of the S&P 500 Index and other major indices – as well as the rate of inflation.
Private REITs, sometimes referred to as private-placement REITs, are neither traded on a national stock exchange nor registered with the SEC. As a result, private REITs are not subject to the same disclosure requirements as stock exchange-listed or public non-listed REITs.
Private REITs issue shares that are neither traded on national exchanges nor registered with the SEC, but rather issued pursuant to one or more of several exemptions to the securities laws set forth in regulations promulgated and enforced by the SEC. These exemptions include rules set forth under Regulation D, permitting an issuer to sell securities to “accredited investors,” and Rule 144A, which exempts securities issued to qualified institutional buyers (QIBs).
Public Non-Listed REITS
Many REITs (whether equity or mortgage) are registered with the Securities and Exchange Commission (SEC) and are publicly traded on a national stock exchange. These are known as stock exchange-listed REITs. In addition, there are REITs that are registered with the SEC, but do not trade on major securities exchanges. These are known as publicly registered, non-exchange traded REITs, or simply public non-listed REITs (PNLRs).
Like stock exchange-listed REITs, PNLRs own, operate and/or finance real estate and are subject to the same IRS rules requiring them to distribute all of their taxable income to shareholders so as to not pay taxes at the corporate level. In addition, PNLRs are required to make regular SEC disclosures, including quarterly and yearly financial reports. All of these PNLR filings are publicly available through the SEC’s EDGAR database.
PNLRs do not offer the same liquidity that stock-exchange listed REITs provide. Redemption programs for shares vary by company and are limited. Generally a minimum holding period for PNLR investment exists.
There are two primary types of REITs: Equity REITs and Mortgage REITs. The two types give investors the opportunity to invest in either the equity financing or the debt financing of real estate.
Equity REITs are real estate companies that acquire commercial properties , such as office buildings, shopping centers and apartment buildings , and lease the space in the structures to tenants, who pay rent. After paying the expenses associated with operating their properties, Equity REITs pay out annually the bulk of the income they collect to their shareholders as dividends. Equity REITs also include capital appreciation from the sale of properties in the dividends they pay. In the case of Timber REITs, their dividends include gains from the sale of timber. In all cases, this significant dividend distribution is designed to approximate the investment return investors would receive if they owned properties directly.
Mortgage REITs invest in real estate mortgages or mortgage-backed securities, earning income from the interest on these investments, as well as from the sales of mortgages. Mortgage REITs, like other businesses, earn their profit from the difference between the income they receive and their costs, including their funding costs to purchase mortgage investments. They have the same requirement as Equity REITs to distribute the bulk of their income to their shareholders annually.
Public Equity REITs and Mortgage REITs may be listed on major stock exchanges, or they may be non-listed. Both are registered with the Securities and Exchange Commission (SEC), but non-listed REITs are sold directly to investors by brokerage firms and are not traded on any exchange. Equity and Mortgage REITs also can be privately held.
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