REIT - Real Estate Investment Trust

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Real Estate Investment Trust also known as REITs were created in US when president Eisenhower signed into law the REIT act. The purpose of the law is to give an opportunity for common investors to invest in large scale diversified portfolio of money making real estate asset by buying and selling securities from a publicly traded market. Since then, more countries around the world cleared way in investing in global real estate securities paving way for individual investors to invest in large scale commercial and residential real estate securities.

Buying and selling REIT securities is one of the best way an individual investor can safely invest in real estate, and expect a decent return on their investment.

Let's say you have $25,000 in cash and you are interested in investing in real estate. It is not possible to buy a real estate property for that money and expect a decent return on your investment in the form of rent. Moreover it is not safe for an individual investor to loan money to an unknown home owner who requires a home mortgage loan, and expect an income from the interest earned on the loaned money. This is were REITs come into play. Real Estate Investment Trust is an investment security that buys and sells its stock in major stock exchange. They invest in real estate properties and make money through interest earned from mortgage loans and through rent earned from the real estate properties. These are known as publicly traded REITs. This provides an opportunity for individual investors to earn a share of income through ownership of commercial and residential real estate properties and mortgage loans. The income producing real estate properties include apartments, home mortgages, shopping malls, office building, resorts, golf courses, storage facilities etc.,

For a company to qualify as REIT, it must have most of its investment in real estate, and must distribute at-least 90% of its income  to shareholders in the form of dividends. This results in higher dividend yield to the shareholders ensuring a good cash flow and a decent return on their investment. Since most of the taxable income is returned to shareholders directly, the dividend is subject to higher(ordinary income tax) tax rates. REIT shares are bought and sold on major stock exchanges. In contrast, buying and selling real estate property directly involves higher expenses, property tax liabilities and great deal of effort.

In general, there are three types of REITs. mREIT or Mortgage REIT, eREIT or Equity REIT, and hybrid REITs.

eREIT - Equity based REIT primarily invest their money by owning real estate properties. The primary source of income comes from rents generated by the real estate assets. As years go on, the rent and the property values goes up, resulting in higher dividend and higher stock value. This is one of the safest and the popular choice of investment.

mREIT - Mortgage based REIT invest their money by owning real estate mortgages. They loan money to real estate investors in the form of mortgage loans. They also purchase existing home mortgage loans and mortgage based stock investments. The primary source of income comes from interest earned by these mortgage loans.  Mortgage based REIT has a higher dividend pay than the equity based REIT.  Mortgage REITs are highly volatile and subject to high fluctuation due to interest rate changes, whereas equity based REITs have a stable growth and less volatility. Due to its high yield dividend, the investment pays itself off to the investor in few years. Even though these trusts seems attractive because of higher dividend yield, it carries higher risk because of the exposure to interest rate. If the interest rate goes up, the value of the mortgage REIT goes down. Best time to invest is during recession time, because that's when the interest rate is expected to go down, and spread-rate (net interest margin) between their income from their mortgage asset and the cost from their borrowed money widens,  resulting in higher profits.

Hybrid REIT invest in a mix of above both strategies. Income gets generated though mortgage interest and real estate rents.

REITs Advantages:

1. High dividend - It is a great source of cash flow for investors focused on high yield dividends.
2. REITs are liquid assets - The assets can be bought and sold in the public stock exchange without affecting the asset price. You can sell your shares online, and get your money back immediately.
3. Diversified real estate portfolio  - Money invested in REITs by the investors like you allows the trust to purchase more real estate properties than an individual investor would be able to buy on their own.
4. Hassle free Investment - Provides investment access to real estate assets without the overhead of property taxes, management fees and legal issues.
5. Asset Appreciation - REIT equity assets appreciate in value over time.

REITs Disadvantages :

1. Not qualified for tax breaks - Most of the REIT dividends are not qualified for tax breaks, so they are taxed at ordinary income rate.
2. Dependent on real estate market - When the real estate market goes down, the asset value goes down. This will reduce the share value of the stock.
3. Dependent on occupancy rate: Less renters will lead to decrease in occupancy rates and that leads to lesser revenues. This will get reflected in the dividend payout.
4. Stock Fluctuations: The shares are subjected to fluctuations caused by short term traders.
5. Interest rate risk: Increase in interest rate will hurt the dividend payout for mortgage based REIT.