REIT Basics | Income Investing Course


Equity REITs are a relatively
new financial innovation that were created
to make it easier for individuals to gain exposure
to real estate investments. Before REITs, investors
typically needed a lot of money to invest in real
estate, particularly commercial real estate. Often, real estate was
owned by partnerships. Only certain types of investors
could participate, typically those with a lot of capital. As a result, accessing
the real estate markets was difficult for
most investors. This all changed in 1960,
when President Eisenhower signed a law creating REITs. REITs were a new
type of corporation that democratized
real estate investing and made it easier for
individuals to gain exposure to investments in real estate. A REIT is a type of
company, or more accurately, a trust, that invests in a
portfolio of real estate. Investors can participate
in the gains and losses of the portfolio by
buying shares of a REIT. Because equity REITs are
publicly traded and listed on the same exchanges as
other companies, buying a REIT is similar to buying a stock. Let’s examine what
a REIT looks like. This is the XYZ
Strip Malls REIT. This REIT invests in commercial
real estate, particularly strip malls. This trust owns strip malls
across the United States. By purchasing a share in
the XYZ Strip Malls REIT, an investor is
able to participate in the profits or losses
generated from this portfolio of strip malls. REITs typically purchase
and maintain real estate. Therefore, part
of the business is making sure the strip malls
are maintained, managed, and occupied. For XYZ Strip Malls,
long-term leases are the primary source of cash. The stores that
occupy space pay rent, which is this REIT’s
main source of revenue. This revenue may be reinvested
to purchase existing strip malls or raw land to develop
into new strip malls. XYZ Strip Malls can also
expand by borrowing money. Doing this introduces
leverage to a REIT. Leverage means controlling a
large amount of real estate with a small amount of money. Too much leverage
is risky, because it could expose XYZ Strip
Malls to interest rate risk. That means if interest
payments move higher, the trust may have to spend more
paying back its borrowed money. Payments on borrowed money,
capital expenditures, and other costs are subtracted
from a REITs revenue. What’s left over is net
income, also known as earnings. As a REIT, XYZ Strip Malls is
required to pay 90% of earnings to investors in the
form of dividends. However, not all
REITs are guaranteed to perform well and
provide steady dividends. REIT management faces
several challenges. One such challenge is
building and expanding a portfolio of investments. For example, if XYZ Strip
Malls expands too far, and buys too many strip
malls, too fast, the trust could have low or even
negative earnings. This could make it
difficult for the trust to provide a dividend
to investors. If a dividend is reduced
or a payment is missed, its shareholders would
likely sell their shares, possibly at a loss, and look
for a better managed REIT. However, if a REIT
performs well, it’s good for the trust
and its shareholders. Now that you know
more about REITs and how they can provide a way
to invest in the real estate market, you can see
why some investors might consider including them in
a diversified income portfolio. [MUSIC PLAYING]

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