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REITs: What are they, what are their advantages, and how to invest in REITs
Much has been said about REITs, or Real Estate Investment Trusts, a new way to get exposure to the real estate market. Find out what they are, what their advantages are and how to invest in them.
REITs are increasingly the preferred choice of real estate investors around the world, including Portugal. With low barriers to entry, stable profitability and a greater degree of diversification, it is easy to see the attractiveness of these trusts. But is this vehicle suitable for all investors? Find out what a REIT is, what their advantages and associated risks are, and learn about the mechanisms available for this kind of investment.
What is a REIT or Real Estate Investment Trust?
REIT is an acronym for Real Estate Investment Trust, or Sociedades de Investimento e Gestão Imobiliária (SIGI), as they are called in Portugal. REITs pay out dividend income to investors derived from property rents. Since rents tend to be stable, the return to the investor can also be considered stable, under regular market conditions.
REITs are therefore a way for investors to earn income without having to buy the property – an opportunity for exposure to the real estate market with fewer barriers to entry than via the traditional route.
REITs may or may not be publicly traded. Publicly Traded REITs can be listed on the most common stock exchanges, which gives them relatively high liquidity. On the other hand, Non-Exchange Traded REITs are available to investors, but are not listed on a stock exchange. Finally, Private REITs are neither purchased nor sold on a stock exchange and are only available to investors designated by their Boards of Directors.
What is the difference between REITs and Real Estate Funds?
While both REITs and Real Estate Funds offer exposure to the real estate market, there are important differences to keep in mind, the first one being the form of investment. REITs invest directly in real estate while funds may obtain this exposure indirectly, for example, by buying shares in real estate companies. Thus REITs generate profitability through rents, and not via appreciation, as funds do.
In addition, REITs are traded on an exchange (in the same way as equities) and valuations change throughout each trading session. Most REITs have a higher liquidity – unlike real state funds that are not traded on an exchange and the valuation of which is updated at least once a day, but in some cases more frequently.
Finally, the criteria for a company to be considered a REIT are tight. Definitions may vary in some countries but, for example, in the United States of America (a model that is replicated by many countries), for a company to be a REIT it must distribute at least 90% of its taxable income to shareholders, invest 75% or more of its assets in real estate, and derive 75% of income from a real estate source (whether from rental, sale or mortgage). On the other hand, it must also be owned by at least 100 shareholders after the first year of operations and have no more than 50% of its shares held by five individuals or less.
What types of REITs are there?
There are various types of REITs, the differences lie mainly in the form and investment product. Some companies specialise in certain assets, and these are the most common.
Mortgage REITs
As the name suggests, this type of REIT invests in mortgages, mortgage-backed securities and related assets. They do not hold real estate in their name, but earn income from the interest that results from mortgage loans. They are considered riskier, as they are subject to loan default by the borrower.
Residential REITs
Residential REITs invest in residential properties, such as houses, flats, single-family homes, and even student or community-specific residences. They tend to focus on geographic markets with higher income and occupancy potential.
Retail REITs
Retail REITs specialise in the acquisition and management of shopping centres, shops and other retail real estate. They own the properties and earn income from the respective rents. Generally, less volatility is observed in activities related to basic commodities, such as food.
Health Sector REITs Health Sector REITs focus on healthcare infrastructure, such as hospitals, nursing homes or medical offices. They have a track record of resilience, even during recessions, as healthcare services are essential for human survival and, therefore, take priority over other businesses.
Logistics REITs
Warehouses for supply chains and industrial purposes are a sub-class of REITs with more cyclical dynamics and depend on economic developments.
Infrastructure REITs
Renewable energy infrastructures (wind and solar), data centres (cloud computing), and mobile data antennas (5G) are assets that may be included in Infrastructure REITs.
Mixed REITs
REITs can also be more diversified and combine products with two or more types of real estate, allowing for a more strategic distribution of risk.
What are the advantages of investing in REITs?
Investing in REITs has several advantages, from a lower initial investment to high liquidity. These are the main ones:
Lower initial investment
The first advantage is lower initial investment. REITs grant access to the real estate market without the need to purchase the property and, moreover, they do not only cover houses, but also hotels, hospitals or shopping centres.
Greater portfolio diversification
A second important advantage is diversification. Investing in REITs allows you to spread your capital over various types of properties and in different geographic locations. A well-diversified portfolio will be better protected against market fluctuations caused by economic, political and social factors.
High liquidity
Investing in REITs tends to benefit from rather high liquidity. You can buy and sell your investment units immediately and the return generally occurs within a short period of time compared to direct investment in real estate.
Generate passive income
Another important advantage is that it generates passive income on a stable and regular basis, as REITs are required to distribute a large percentage of taxable income (rental income) to shareholders.
Professional management
REITs also benefit from professional management. For the investor, it means less time wasted and greater confidence, since the management is entrusted to experts, and all you have to do is follow the developments on the stock exchange.
What are the risks of investing in REITs?
Despite the advantages described above, investing in REITs also presents some risks, as with any passive income. REITs are exposed to market risks, that is, they can significantly devalue as a result of social, economic or political developments. For example, the crisis that the hotel industry suffered during the pandemic led the REIRs exposed to this sector to significantly fall.
Furthermore, as REITs distribute a large percentage of profits, capital is rarely reinvested for growth purposes. Thus, significant long-term capital appreciation is less likely.
How to invest in REITs?
Investors can invest in REITs in 3 different ways: buying REIT shares, investing through an ETF (Exchange Traded Fund), or invest through specialised investment funds. To invest with confidence, you can rely on a specialised partner, Banco Carregosa, with a long and solid experience in investment management. Start investing in REITs and take advantage of our 180 years’ experience to support you at all times.