Investing directly in real estate can be a lot of work, and associated fees, transaction costs and taxes may run very high. In the beginning, you may need to involve agents, brokers, contractors and banks, then engage with tenants going forward. And the terms of a mortgage or loan you'll be offered probably won't be as great as what REITs can get.
Not to mention that if you want to manage your real estate personally, you're confined to the geographical area you live in or frequent. For some people, therefore, investing in REITs instead might be an attractive alternative.
As discussed in our article 'What is a REIT?', most real estate investment trusts are equity REITs. They operate like a landlord, as they own, develop and operate income-producing real estate investments, like shopping malls or office buildings. You can easily invest in different real estate sectors by buying REIT shares through an online brokerage account. While everyday investors cannot afford to buy into retail properties, hospitals or data centers to diversify their real estate investments, REITs make this easy.
REITs can also help you to further diversify your portfolio, by investing in real estate on another continent and earning income in a different currency than where you live.
While dividends are optional for most other companies, US REITs by law need to pay out at least 90% of their taxable income to shareholders.
Investing in REITs
Where to buy REITs?
To buy a (publicly traded) REIT, you'll need an online broker that provides access to the stock exchange the REIT in question is traded on.
For example, if an investor residing in Malaysia would like to invest in a US REIT like the Simon Property Group (NYSE:SPG), they'd need an online broker that has access to the US market (in this example, the New York Stock Exchange), which the majority of the brokers listed here at BrokerChooser do.
On the other hand, an investor looking to invest in an Australian REIT trading on the Australian market would need to select a broker that can access that market.
If you go to any broker review on BrokerChooser and navigate to the 'Fees' chapter, you'll see a summary of the most important exchanges the broker gives you access to.
Investing in REITs
REIT ETFs and CEFs
Just as with stocks in other sectors, there are many ways an investor can invest in REITs.
For those who prefer not to actively engage in choosing which individual REITs they think will perform well, going with a REIT Exchange Traded Fund (ETF) might make sense. An argument against these ETFs, however, is that they tend to be heavily invested in popular, highly valued REITs and therefore the dividend they pay is usually low relative to their price.
With mutual funds and closed-end funds (CEFs) you can get active management, but this can come with a high cost. Management fees are often above 1% per year and because of these fees, most funds will underperform the market (and the index-linked ETFs). With CEFs comes an additional risk as they can use leverage to enhance their returns, but the flipside of this is that in bad times losses can also multiply.
Investors who like to manage their portfolios themselves might be interested in adding some individual REITs after careful analysis. And unlike some other sectors, like biotech, the business model of some equity REITs can be easily understood by everyday investors.
Continue to the next chapter to read about some metrics that are often cited and looked at by REIT analysts.
Investing in REITs
Metrics for REITs
The most important and most widely used indicator used to describe a REIT's size and assess its value is Net Asset Value (NAV).
The NAV is the market value of all the company's assets, like their properties and cash on hand, after subtracting the market value of all its liabilities and obligations.
Historically, REITs often trade around or close to their NAV per share, as the NAV reflects an estimate of the actual value of the properties. Note that the NAV can differ from the book value. For example, a REIT might have purchased a mall a decade ago. If that mall performed poorly and is not expected to rebound, the book value will be much higher than what is accounted for in the NAV.
Depending on the prevailing market sentiment, you can sometimes buy REITs below their NAV, which can be similar to buying real estate at a bargain price.
Note that if a REIT trades above its NAV, it makes sense to issue new shares if they use the proceeds to expand their business, thus creating additional value for shareholders.
Conversely, if the share price is significantly below the NAV, issuing new shares would be a dilutive move and frowned upon by investors.
The most commonly accepted and reported measure of a REIT's operating performance is FFO, or Funds From Operations. It is equal to a REIT's net income, excluding gains or losses from sales of property and adding real estate depreciation.
If you deduct the amount spent on investments (capital expenditures, or capex) from the FFO, you'll arrive at the Adjusted Funds from Operations (AFFO).