Investing in REITs | Ralph L. Block

Summary of: Investing in REITs: Real Estate Investment Trusts (Bloomberg)
By: Ralph L. Block

Introduction

Are you seeking a low-risk, high-return investment that also serves as a hedge against stock market downturns? Dive into the world of REITs, or Real Estate Investment Trusts, which have been providing investors with an average annual total return of 12%. In our summary of ‘Investing in REITs: Real Estate Investment Trusts’ by Ralph L. Block, you will learn about different types of REITs, their growth potential, and their appeal to a wide variety of investors. Additionally, we will explore the factors that influence REIT performance, such as the cyclical nature of the real estate market and the role of management teams.

REITs – A Safe and Lucrative Investment Option

Real estate investment trusts (REITs) offer low-risk, low-volatility, and high-return investment opportunities. With average total returns of 12%, they provide a hedge against stock market downturns. REITs have outperformed the S&P 500 while being independent of its performance. The commercial real-estate market is valued at $4 trillion, while REITs manage only 10% of it, hence having significant growth potential. They are a lucrative investment option, with $300 billion invested in them, equivalent to Microsoft’s shares. Discover the benefits of REITs and start investing today.

Understanding REITs

Real Estate Investment Trusts (REITs) are special corporations that enable investors to earn steady income and low market-price volatility with high investment safety. They own, lease, renovate and manage real estate like houses, apartments, hospitals, office buildings, and golf courses. Unlike a typical public company, a REIT must have at least 100 shareholders and distribute its shares broadly. REITs must invest at least 75% of their assets in real estate, mortgage loans, and other REITs, and they must earn at least 95% of their income from rents, interest, property sales, dividends, or stock sales. REITs can be a great option for investors who do not have time to manage property and seek liquidity without compromising diversification. The Real Estate Investment Trust Act of 1960 enables REITs to avoid paying corporate tax if they pay out 90% of their net income to shareholders.

REITs and Real Estate Market Cycles

Real Estate Investment Trusts (REITs) performance is determined by the highly cyclical real-estate market that moves through four phases: depression, recovery, boom, and downturn. Different property types experience different phases at different times, and savvy REIT investors will focus on many types of property, instead of putting all their eggs in one basket. Approximately $300 billion was invested in REITs as of 2004, with office, industrial, retail, residential, healthcare, lodging, resorts, self-storage, and “specialty properties” being the primary areas of focus. Investors should consider both local conditions and broad economic cycles when considering if and when to invest in specific REITs.

REITs: A Guide to Understanding Profitability

REITs utilize “funds from operations” (FFO) as the primary measure of profitability. Unlike net income, FFO looks at income before the deduction of depreciation expenses. It is important to keep in mind that FFO is not the perfect measure of REITs’ profitability. Adjusted FFO, which accounts for non-value adding expenses and costs, is another valuation measure to look at. To further grow their FFO, REITs use either internal or external growth models. Investors should look for REITs with an experienced management team, access to capital, a strong balance sheet, a geographic and sector focus, managers who own stocks in the REIT, cash reserves, and no conflicts of interest.

Real Estate Investment Trusts (REITs) offer investors an opportunity to invest in real estate while avoiding the responsibilities of owning a property. Unlike traditional real estate investing, REITs enable anyone to invest in a diversified range of properties due to the low costs of investment. However, before diving into the world of REITs, it is vital to understand how they generate profits and grow as a company.

The commonly used measure of profitability for a company is net income. But when it comes to REITs, “funds from operations” (FFO) is the most widely used measure of profitability. Real estate companies, including REITs, depreciate for accounting purposes, which is considered an expense. However, well-maintained and well-managed properties that REITs own usually increase in value and generate more income over time. Because of this, net income doesn’t capture the value of a REIT as accurately as FFO. Therefore, FFO looks at net income before deducting depreciation expenses. It is important to keep in mind that FFO is not the perfect measure of REITs’ profitability. Adjusted FFO, which accounts for non-value adding expenses and costs, is another valuation measure to look at.

REITs can grow their FFO by using either internal or external growth models. Internal growth comes from increasing profits through rent hikes, expense sharing with tenants, and improving tenant quality. On the other hand, external FFO growth comes from acquiring additional properties with high yield growth or developing properties. Some REITs grow through joint ventures, while others provide financing for real estate deals.

To find the right REITs that deliver consistent FFO growth throughout the ups and downs of the real-estate cycle, investors should look for specific attributes. An experienced management team is a good indication of a REIT that has seen various market conditions, chalked up good FFO growth in both fat years and lean, and knows how to attract the best tenants. Access to capital is essential, and investors should make sure their REIT effectively uses the available capital. A strong balance sheet is significant, and investors should monitor debt ratios, as well as the maturity of the debt and whether any of it is subject to a variable rate. A geographic and sector focus is necessary, and investors should look for REITs that have expertise in a specific territory or property type. The management team owning stock in the REIT is another excellent indication of alignment between the board and investors. Cash reserves are essential for REITs for flexibility in financing new projects and paying dividends. Lastly, investors should research whether the REIT has any conflicts of interest, such as buying overpriced apartments owned by its managers.

REITs may be a complex investment option, but understanding their features and growth models is key to investing successfully. Investors should keep an eye out for REITs that meet the above requirements, as they are likely to provide solid returns with little risk.

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