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How to Invest in REITs

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A real estate investment trust (REIT) is a relatively new asset in the portfolios of wealthy investors. Ever since REITs became available in India, there has been an attraction towards them as a top choice in the portfolios of high-net-worth individuals.

But what are they and are they good investments?

Let’s find out...

What is a REIT?

In simple words a REIT is a company, that raises funds from investors and invests the funds in a portfolio of real estate assets. It also controls and manages the real estate portfolio.

The real estate assets generates rental income which is distributed to the shareholders of the REIT. Thus investors in a REIT earn steady income in the form of dividends from the real estate assets in the REIT without having to directly invest in these assets themselves.

How to Buy REITs?

REITs are listed on stock exchanges and trade in the same way equity securities do. This makes REITs highly liquid as opposed to the underlying physical real estate assets in the REITs which are highly illiquid.

What kind of real estate do REITs buy?

The purpose of REITs is to generate regular, stable income for its investors. So REITs mostly invest in income producing real estate. All other things being equal, the higher the rental yield the better.

Property types include but are not limited to, residential buildings, housing complexes, office buildings, commercial parks, hotels and resorts, data centers, hospitals, warehouses, retail spaces like malls, etc.

What is the yield on a REIT investment?

REITs trade on the stock market. Thus their price in the market, at any given time, will decide the yield for an investor.

The REIT yield is easy to calculate as they are required by law to distribute 90% of their income as dividends. This can be reasonably estimated on a per share basis by investors based on past dividends.

REIT Yield (%) = REIT Annual Dividend Per Share / REIT Share Price * 100

What is the capital appreciation in a REIT?

There isn’t much capital appreciation in a REIT and investors shouldn’t expect any. The purpose of REITs is to distribute most of their income as dividends.

As they pay 90% of their income as dividends, they can on reinvest 10% of their income back into the business to buy new properties.

What are the pros and cons of REIT Investments?

Stable cash flows are a major advantage of investing in a REIT. It is the reason why wealthy investors choose REITs as an investment.

Being able to make low ticket size investments in real estate is a huge advantage of REITs. At the cost of just one share of a REIT, investors are effectively investing in an entire real estate portfolio.

Also REITs invest is a wide variety of real estate assets. This provides the benefit of diversification. However, there are REITs that specialise in one type of property, like IT parks or hotels. These REITs won’t offer diversification.

Buying real estate aways involves concerns about transparency and potential fraud. That is not the case in a REIT investment. Investors can rest assured they are investing in high quality real estate.

On the flip side, there isn’t much capital gains on offer.

REITs are listed on the stock markets. So, they behave as stocks with much lower volatility than the rest of the market. Still they will be subject to general market risk.

Finally, dividends are not guaranteed. REITs can only distribute the dividends they receive. If the real estate market is severely impacted due to a bad economy, tenants may not be able to pay rents. This will negatively impact the dividend payout.

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