Investing in Commercial Real Estate through REITs

Stocks have long been the foundation of portfolios, while bonds populate the investment techniques of the more cautious investor.  Options boost leverage, while mutual funds are the easiest tool to gaining diversity.  However, there is one other financial tool that many retail investors do not utilize fully - the Real Estate Investment Trust or REIT.

An REIT is a trust company that submits an IPO to obtain investment funds for real estate developments.  The IPO is the same as any other security offering, but instead of purchasing shares of stock from one company, the investor is buying a share in a managed pool of real estate properties.  The REIT holders profit through the management of the property, including renting, leasing, and selling.

Benefits of REITs

Each time you purchase a REIT’s share, you are essentially buying a physical piece of property, which is a lasting investment with plenty of potential income.  You receive a stake not only in the ownership, but also in the income that is generated from renting or selling the property.  This creates a safety net for your profits.

A second advantage of REITs is that you can invest in the real estate market without some of the headaches involved – you can benefit from property growth without investing a significant amount of capital or time.  In addition, because the funds of the trust are used together, the investment can be diversified with more properties, so that one bad property does not present a tremendous risk to your overall bottom line.  In order to get the same diversification benefits of a REIT on your own, you would have to buy several properties.

Another important advantage of REITs is that they distribute 90% of their yearly taxable income to the shareholders.  This feature provides strong cash flow to the shareholder which translates to higher yield for you.
Lastly, REITs are very liquid investment because they trade like other stock shares on a public exchange. This is in contrast to actual individual land and other real estate ownership which takes time to market and is subject to specific market risk and higher sales costs.

Other REIT considerations

Like any other investment, you need to weigh your options before choosing a REIT.  Especially if the real estate market is experiencing decline or fluctuations, it is important that you select a solid investment with longevity.  There are several things you should seek before you invest your money.

A primary consideration is the management of the properties.  Understanding the track record of the management team is critical, as most of your potential profits are tied up in the manager’s skill.  The manager must select the right investments and strategies to generate profitable returns.  If the management team is compensated based on their performance, then they are more likely to be in line with your interests, in contrast to a team who does benefit from performance-based compensation.

You should also consider the diversification within the REIT.  The real estate markets can fluctuate just like any other investment market, and the profits of your REIT are tied up in the real estate that you own.  It is important to select a diverse REIT that can weather the changes in the market.  You also want to make sure that the trust has enough potential capital to continue to grow and earn increasing returns.

Finally, you want to look at the earnings of your REIT.  Look at the income funds from operation and the money available for distribution, as this directly affects the yield that the investors will receive.  You cannot look at these numbers without the prior two considerations, since a lucky guess on the part of the manager can give you a false impression as to the future of the investment.

Capitalizing upon the profits of the real estate market does not require significant capital or down payments.  By carefully selecting diversified and well-managed REITs, your portfolio can benefit from the profitable growth of tangible real estate assets.