Real Estate Investment trusts (REITs) basics

reits

Over the last years, a new vehicle promising to give investors a nice ride became very popular, it is the real estate investment trust, or REIT (pronounced “reet”). REITs are a bit different than the traditional real estate investments.

Investing in REITs would require us to cover REIT basics. We shall focus on their characteristics as investment vehicles as well as the technical aspects that makes REITs unique in the world of not just real estate investment vehicles, but investment options in general.

REITs have grown in popularity since their introduction in the US by the REIT Act of 1960. Recognizing that large commercial properties were most commonly owned by financial institutions and the wealthy, the US Congress devised a way for individual investors to own their very own portion of shopping malls, office buildings and other expensive real estate. REITs can be thought of as companies established for the exclusive purpose of owning real estate-related assets. By making shares in the REIT itself available for public investment, these once-un- attainable investments became avail- able in bite-sized chunks.

Kenya’s Real Estate Investment Trusts (RElTS) are part of the Nairobi Securities Exchange(NSE). The CMA has been pushing for establishment of public Reits in Kenya for many years. With the recent growth and maturity of the real estate sector this has been long overdue. Kenya will become the 41st country in the world to introduce REITS and second in Africa after South Africa

In just the past decade, the glob- al equity market capitalization of REITs has ballooned from $300 bil- lion to around $1.4 trillion, accord- ing to available statistics. While the U.S. remains the largest listed real estate market, the listed real estate market is increasingly becoming global. The growth is being driv- en importantly, by the appeal of REITs. The most common index for the REIT and global listed property market is the FTSE EPRA/ NAREIT Global Real Estate Index Series, which was created jointly by the index provider FTSE Group, NAREIT and EPRA, the European Public Real Estate Association. The index is used by a variety of institutional investors, money managers and funds to manage real estate investment on a global basis. It contains both REITs and non-REIT list- ed property companies. The Global Index Series contains the Developed Markets indices and the Emerging Markets indices. As of September 30, 2015, the FTSE EPRA/NAREIT. Global Real Estate Index included 487 stock exchange-listed real estate companies in 38 countries around the globe. Of the $1.2 trillion in equity market capitalization represented in the Developed Markets index (Over $1,4 trillion including emerging markets too), 79 percent came from REITs.

Historically, REITs have fall- en somewhere between stocks and bonds in terms of risk profile. In other words, they should be thought of as a bit riskier than bonds, but not quite as risky as stocks. And since they have qualities of both, under- standing and valuing REITs requires analysis used for both stocks and bonds. REIT dividend payments can be thought of like bond payments, and like bonds, higher cash flow is often equated with higher risk. But REITs directly own real estate assets, so the fundamentals of the properties and markets in which the REIT invests will impact appreciation (or depreciation) and ultimately the movement of REIT shares.

In theory, REITs provide investors several advantages compared to direct ownership of real estate.

Liquidity

One of the main disadvantages of traditional real estate investments is the low liquidity that they usual- ly provide. Publicly traded REITs are highly liquid, meaning investors can buy and sell shares in seconds just like stocks. Not so with physical properties, which not only take months (if not longer) to buy or sell, but are also laced with transaction expenses like brokerage commissions, transfer taxes, escrow fees, and other costs.

Diversification

Because shares are sold at a relatively low value, investing in REITS makes it easy to balance portfolio diversification and allocate away from stocks and bonds. And since most REITs focus on a specif- ic property type or geographic region or both, returns aren’t tied to a single property or single neighborhood’s performance.

Cash Flow Plus Appreciation

REITs distribute most of their net income to shareholders via dividends. This means REIT investments – provided they are doing well – kick off consistent cash flow to investors, much like bonds. In addition, if real estate prices rise and properties are sold for a profit, investors can receive equity distributions back, cashing in on appreciating markets. The knife, however, cuts both ways: REITs saw fantastic losses as the real estate market tum- bled from 2006 to 2009 in several countries around the world and that affected the investors too.

Ease of Management

Owning REIT shares is as easy as owning a stock. No late-night calls from tenants, no bursting pipes. Those events still happen, of course, so their cost still impacts REIT performance, but the headaches of owning real estate do not come along with owning REITs.

Out of Sight, Out of Mind

One oft-touted benefit of REITs is the chance to invest alongside some of the smartest real estate minds the investing world has to offer. REITs are often run by successful real estate industry experts who literally spend their lives trying to make good real estate investments. But if these experts are so savvy, why did precious few of them see the real estate collapse coming, resulting in millions of dollars in losses for REIT investors a few years ago? Owning an apartment building that you drive by on the way to work may be a hassle, but you aren’t relying on someone else to notice when the roof needs fixing. And if your own backyard turns out to be a great place to buy real estate, diversification away from your core market isn’t a positive at all.

Dumping Grounds

REITs often become the dump- ing ground for unwanted or under- performing assets. Selling shares to the public is a way for real estate operators to raise capital, and as economists usually say, companies only raise capital when they’d be crazy not to — or when they have to. So now that we know some of the positives and negatives of invest- ing in REITs, let’s take a step back. What is a REIT, anyway? There are three primary types of REITs, and each one pretty much does what its name suggests. Equity REITs own real property, Mortgage REITs own mortgages Hybrid REITs own a combination of property and debt.

Each one still has to meet the required from the CMA minimum specifications in order to retain its REIT status, but the nomenclature helps investors know what type of assets the REIT owns and hints at what sort of risk-reward dynamics they can expect.

REITs are also identified by the types of real estate assets they hold, which include residential (apartments), retail, office, industrial, health care, self-storage, hotel, and resort. Further, many REITs have a geographic focus, allowing investors to pick and choose not only what type of properties they are invest- ing in, but also in what locations. Of course, some REITs are so big that they own properties all over the country, but most are focused to some degree in both property type and geography.

The word invest is connected with the word risk. The property market has traditionally been one of the most favorable around the world, but investing our family’s savings and future in real estate requires a lot of attention and proper knowl- edge. Direct investments or investing via REITs or any other vehicle is not providing in any way 100% security. I always recommend that if you feel that you do not have the knowledge, experience or time to follow up with your investments, either use a professional accredited advisor or skip the investment.

kostakioleoglou

Article by Kosta Kioleoglou REV

Civil Engineer Msc/ DBM

Media 7 Group Kenya – Business Monthly