This is an investment type that I personally love. This investment is exactly what it sounds like. It is real estate in a trust managed by professional managers. It is a fact that the average person doesn’t have enough funds to make their own real estate investments so this is a way that you can purchase real estate backed assets for your portfolio without having a huge net worth.
How do these funds work?
The basic concept is simple. These funds will consist of a type of real estates that the investment managers will buy for the fund. There are two types of real estate which would be residential and commercial. Often times these funds either have one or the other but not booth of these investment types.
The Basics of REIT’s
- The managers of the company will choose a niche of properties to purchase. An example would be commercial properties in the healthcare industry or commercial retail. This is how most of these funds are managed.
- You buy shares of the fund. Most of these are purchased like ETF’s or Common Stock. You go onto the open market and get shares in any amount.
- Your fund will pay you dividends. There are two important things to know about REITs. First, These funds pay out 90% of the money earned to the holders in the form of dividends. This is required by law for a company to operate as a REIT. Second, these dividends are taxed at your regular rate. If you are in a height tax bracket I would advise you to learn more about this. It might not be suitable for you.
Analyzing These funds
I will say upfront that these are not the same as most companies so you will need to have specialized analyst skills to fundamentally understand these funds.
One of the most important things for any REIT is there average rental cost. This actually goes across the whole real estate industry. As a general rule, these companies want to have a high average rate per rental. The higher this is, the better quality the tenets are.
You want the rentals to always be at full occupancy. I have found some REIT’s that are 96% occupied which is really high. If the buildings don’t have tenants than it there is no reason to be invested in them. This means that the managers aren’t utilizing all the assets they own and are losing money.
With a normal company they purchase assets and they lose value over time. With a REIT, this is a little different. In fact, it is almost the opposite effect because there is a higher chance that the real estate will gain value meaning that they appreciate. When judging the net income many REIT analysts subtract the depreciation off the books.
According to GAAP accounting principles, everything needs to be depreciated on a straight line scheduled. For buildings, this is often a 30-year straight line schedule meaning that the same amount is depreciated every year. For this type of investment, the tenets might make improvements to the property and the buildings might become more value instead of losing value.
Managers Track Record
One thing that some REIT investors learned the hard way over the years it to make sure that management of these companies is ethical. There have been cases in the past where management has been double dipping in managment fees so it is important to know if any officers have a conflict of intrest. Some of the people reading this will know which REIT I am reffering to, but I feel like they don’t need to be called out by name.