Real estate investment trusts also known as REITs are a type of corporation that, must invest only in real estate. Investing in REITs enables individual investors to participate in income-producing real estate investments without owning physical real estate. REITs do not have to pay U.S. federal income tax as long as they pay out at least 90% of their income in the form of dividends to their shareholders. To qualify as a REIT, a company must meet the following requirements:

• its assets must consist mainly of real estate held as a long-term investment
• its income must be mostly derived from real estate
• it must pay out a minimum of 90% of its taxable income to it’s shareholders

Since a REIT must pay out most of its earnings to shareholders, REITs must raise more capital by borrowing or by selling more shares to fund expansion.

The major categories of REITs are:

• Equity REITs own physical properties such as apartment houses, shopping centers, office buildings, or other type of real estate.
• Mortgage REITs invest in mortgages and do not own real estate properties.
• Hybrid REITs both own properties and makes loans to real estate owners and operators.

REITs are allowed to provide the customary management services associated with leasing properties such as apartment buildings, shopping centers and office buildings. But REITs are not allowed to operate real estate that requires a high degree of personal service such as hotels and healthcare facilities. Recent regulatory changes, however, allow REITs to create affiliated companies that can provide management services in these sectors.

REIT are generally divided into the following categories:

• Residential: apartment and manufactured home community owners.
• Retail: shopping centers, outlet centers, small neighborhood centers, or downtown/heavily trafficked retail locations. Retail power centers are shopping centers with three or more “big box” anchors such as Toys R Us, Home Depot and Target.
• Industrial: industrial, warehouse, or distribution center properties. Flex properties are a recent innovation in industrial real estate. These are one-story buildings with high ceilings, rear loading docks, surface parking and generous landscaping. Flex building shells are designed to accommodate companies needing office, light manufacturing and/or warehouse space.
• Office: office buildings are generally categorized as Class A, Class B, or Class C, depending on amenities and location, and Class A is the best. Class B buildings are usually in suburban neighborhoods. Class C buildings are usually older and in low-rent areas.
• Mixed Industrial/Office: many REITs own both office and industrial/warehouse properties.
• Healthcare: owners, but not operators, of healthcare facilities such as nursing homes, medical office buildings, hospitals, etc.
• Lodging: hotels and resort properties. Lodging REITs are not allowed to directly manage their hotel operations, but many arrange management contracts with affiliated companies.
• Mortgage/Finance: REITs that invest in mortgages, or provide mortgage or other types of financing.
• Specialty: self-storage centers, restaurant property owners, and other REITs that do not fit into the major categories.
• Diversified: REITs that own properties in multiple categories.

Why do people invest in REITS?

REITs are total return investments. They typically provide high dividends plus the potential for moderate, long-term capital appreciation. Long-term total returns of REIT stocks are likely to be somewhat less than the returns of higher risk high-growth stocks and somewhat more than the returns of lower risk bonds. Because most REITs also have a small-to-medium equity market capitalization, their returns should be comparable to other small to mid-sized companies.

There is a relatively low correlation between listed REIT returns and the returns of other market sectors. Thus, including listed REITs in your investments helps build a diversified portfolio.

REITs offer investors:

• Current, stable dividend income
• High dividend yields
• Dividend growth that has consistently exceeded the rate of consumer price inflation
• Liquidity: shares of publicly traded REITs are readily converted into cash because they are traded on the major stock exchanges
• Professional management: REIT managers are skilled, experienced real estate professionals
• Portfolio diversification, which reduces risk
• Oversight: Independent directors of the REIT, independent analysts, independent auditors, and the business and financial media monitor a public REIT’s financial reporting on a regular basis. This scrutiny provides an investor a measure of protection and more than one barometer of the REIT’s financial condition.
• Disclosure obligations: REITs whose securities are registered with the SEC are required to make regular SEC disclosures, including quarterly and yearly financial reports.

What One Should Look For When Investing In REITs

The market usually rewards companies that demonstrate consistent earnings and dividend growth with higher price-earnings multiples. Thus, investors should look for REITs with the following characteristics:

• A demonstrated ability to increase earnings in a reliable manner. For example, look for companies with properties in which rents are below current market levels. Such properties provide upside potential in equilibrium markets and downside protection when economic growth slows.
• Management teams able to quickly and effectively reinvest available cash flow. The ability to consistently complete new projects on time and within budget. Creative management teams with sound strategies for developing new revenue opportunities under the REIT Modernization Act.
• Strong operating characteristics, including effective corporate governance procedures, conservative leverage, widely accepted accounting practices, strong tenant relationships and a clearly defined operating strategy for succeeding in competitive markets.

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