How is the value of real estate investment trust (REIT) shares typically determined?
- The expected increase in earnings per share; Expected total return from the stock, based on the expected price change and the current dividend yield;
- Current dividend yields in comparison to other yield-oriented investments (for example, bonds, utility stocks, and other high-income investments);
- Dividend payout ratios as a percentage of REIT FFO
- Quality of management and corporate structure; and
- The underlying asset values of real estate and/or mortgages, as well as other assets.
Is it necessary for REITs to pay dividends?
How do REITs assess their earnings and dividend-paying ability?
What are the most common elements that generate REIT earnings growth?
Advantages and Disadvantages of Investing in REITs
REITs can be an important part of an investment portfolio because they provide a strong, consistent annual dividend as well as the possibility of long-term capital appreciation. Over the last 20 years, REIT’s total return performance has outperformed the S&P 500 Index, other indices, and the rate of inflation. REITs, like any other investment, have some pros and cons.
On the plus side, because most REITs trade on public exchanges, they are simple to buy and sell—a feature that mitigates some of the traditional drawbacks of real estate. REITs provide attractive risk-adjusted returns and consistent cash flow. Furthermore, a real estate presence can be beneficial to a portfolio because it provides diversification and dividend-based income—and the dividends are frequently higher than those available from other investments.
On the negative side, REITs do not provide much in terms of capital appreciation. As part of their structure, they are required to return 90 percent of their income to investors. As a result, only 10% of taxable income can be reinvested back into the REIT to purchase new holdings.
- Dividends provide consistent cash flow.
- Risk-adjusted returns are appealing.
- Slow growth
- Dividends are taxed in the same way as ordinary income.
- Market risk exists.
- High management and transaction fees are possible.
- REIT Scam
Investors are advised to be aware of anyone attempting to offer REITs that aren’t registered with the Securities and Exchange Commission (SEC). It suggests that “The SEC’s EDGAR system can be used to check the registration of both publicly listed and non-traded REITs. You can also use EDGAR to look over a REIT’s annual and quarterly reports, as well as any prospectus that may be available.”
Check out the broker or investment advisor that recommended the REIT. You can use the SEC’s free search tool to see if an investment professional is licensed and registered.
Dangers of Non-Traded REITs
Investors in non-traded REITs, also known as non-exchange traded REITs, face unique risks because they are not traded on a stock exchange.
Because non-traded REITs are not publicly traded, investors are unable to conduct research on them. As a result, determining the REIT’s value is challenging. Even though some non-traded REITs will publish all assets and value after 18 months, this isn’t reassuring.
Non-traded REITs are also illiquid, which implies that when an investor wishes to trade, there may not be any buyers or sellers in the market. Non-traded REITs, in many situations, cannot be sold for at least seven years.
Non-traded REITs must pool funds to purchase and operate properties, securing investor funds. This pooled money, however, may have a darker side. The darker side is when a property pays out dividends from other investors’ money rather than profits earned by the property. This approach reduces the REIT’s cash flow and lowers the value of its stock.
Upfront fees are another disadvantage of non-traded REITs. The majority demand an advance fee of between 9% and 10%, with others charging as much as 15%. There are instances where non-traded REITs have exceptional management and properties, resulting in stellar profits, but this is also true with publicly-traded REITs.
External manager fees are also possible in non-traded REITs. External management is paid by a non-traded REIT, which reduces investor returns. If you decide to invest in a non-traded REIT, make sure you ask all of the pertinent questions about the dangers listed above. The more openness there is, the better.
Risks of Publicly Traded REITs.
REITs that are publicly traded provide investors with an opportunity to add real estate to their portfolio while also earning a healthy dividend. Although publicly-traded REITs are safer than non-exchange REITs, there are always hazards.
Risk of Interest Rates
The largest threat to REITs is a rise in interest rates, which diminishes REIT demand. In a rising-rate environment, investors tend to gravitate toward safer income investments like U.S. Treasuries. Treasury bonds are government-backed and pay a set rate of interest. As a result, when interest rates rise, REITs fall off, while the bond market rallies as money pour into bonds.
Selecting the Wrong REIT
The other major danger is picking the wrong REIT, which may seem obvious, but it’s all about logic. Suburban malls, for example, have been on the decline. As a result, investors may be hesitant to participate in a REIT with a suburban mall exposure. Urban shopping centers may be a superior play for Millennials who prefer city living for convenience and cost savings.
Because trends vary, it’s critical to investigate the REIT’s properties or holdings to ensure that they’re still relevant and capable of generating rental income.
How does a business become a REIT?A corporation must meet the following criteria to be classified as a REIT:
- At least 75% of its total assets should be invested in real estate.
- Rents from real estate, interest on mortgages financing real estate, or sales of real estate must account for at least 75% of gross income.
- Each year, pay at least 90% of its taxable profits to shareholders in the form of dividends.
- As a corporation, you must be a taxable entity.
- A board of directors or trustees will oversee the operation.
- A minimum of 100 shareholders is required.
- Have no more than five people owning more than 50% of the company’s stock.
What is a Paper Clip Real Estate Investment Trust (REIT)?
A “paper clip REIT” maximizes a REIT’s tax benefits while also allowing it to operate properties that other trusts are unable to. The paper clip REIT has a tight fiduciary duty to stakeholders, which can lead to conflicts of interest. As a result, this type of REIT is uncommon, and when it does exist, it is subject to intense regulatory scrutiny. Its structure is comparable to that of a “stapled REIT,” but it is more flexible.