Investing in REIT funds: features, advantages and possible risks
Investing in real estate is considered to be the most reliable way of investing funds. Against the background of declining demand for real estate and rental rates, many investors prefer to use more advanced tools. One of the most relevant ways to invest in real estate are REIT funds. Such companies allow you to invest in any real estate sector, including foreign.
What are REIT funds?
These are companies specializing in the sale and leasing of real estate, as well as the purchase of mortgage-backed securities. Such real estate funds are arranged on the principle of mutual funds with the difference that investors invest their funds not in the purchase or construction, but acquire shares of the fund, which can be sold at any time. At the same time, the regular income of the investor is dividends. In comparison with other ways of investing in real estate, investing in REIT funds allows private investors to earn money without buying real estate, which means that you can start with a small start-up capital.
A REIT fund can take advantage of a benefit in terms of exemption from capital gains tax, but for this it must meet certain requirements, in particular:
- 75% of the fund’s assets should be real estate or mortgage-backed securities;
- at least 75% of income should be generated from real estate-related assets;
- at least 90% of the income should go to the payment of dividends to investors.
Classification of REIT funds
The vast majority of REIT funds are formed on the principle of equity participation. They invest in the purchase of real estate, rent them out and thus receive income.
The second category consists of funds specializing in the purchase of mortgage-backed securities, in particular mortgages from banks. At the same time, the income of the funds consists of interest payments on securities.
There are also hybrid (mixed) REIT funds, whose assets are both real estate and mortgages, and their income consists of rent and interest payments.
In the narrow real estate sector, the REIT classification provides for a division into funds investing in:
- office buildings and adjacent territories;
- production and industrial areas;
- commercial facilities;
- recreation centers and hotels;
- apartments for various purposes;
- medical institutions and laboratories;
- forest lands;
- premises for hosting servers;
- cultural sites;
- real estate objects of different purposes at the same time.
Advantages of REIT funds
To date, REIT funds as an independent form of ownership and management of real estate are legalized in 37 countries of the world, and this is a good option for going beyond the boundaries of habitual investment.
If we talk about the advantages of REIT funds, it is important to highlight the following:
- REITs are interesting in terms of diversifying a wide investment portfolio due to the fact that they work with real estate around the world;
- high profitability due to the special status of funds. Investors can earn more profit on REIT shares than on shares or bonds of companies not related to the real estate sector;
- reliable protection against inflation due to the fact that the fund’s assets are little exposed to market dynamics and do not depend on other assets. While other investors incur losses, investing in a REIT makes a profit. Such a picture, for example, was observed in 2008, when the entire world economy was in deep crisis.
- good liquidity. In this case, the liquidity of REIT assets is determined by the fact that it is much easier and faster to sell shares of the fund than to sell physical real estate or part of it in the form of a unit.
Evaluation and selection of a REIT fund
When evaluating and choosing, it follows from the fact that the REIT is essentially an ordinary company, which means you need to focus on its performance indicators. And here are some of them it is advisable to rely on:
- cash flow from fund operations (FFO), equal to the sum of net income and depreciation. This is the main indicator that is calculated according to the profit and loss statement;
- cash flow from operations per share (FFO/S multiplier) compared to the previous period. The dependence of dividends on this indicator is direct. If the multiplier increases, the dividends also increase. At the same time, a decrease in the indicator indicates either a decrease in the flow of funds, or an increase in the number of shares;
- the P/FFO multiplier. This indicator is used to compare funds. It is believed that the lower the ratio, the more profitable the fund’s shares are. For the sake of objectivity, it is worth noting that it is necessary to compare funds operating in similar sectors.
How to invest in a REIT
Investing in REIT funds seems to be one of the simplest ways to invest funds, since it does not require an investor to independently analyze the market and form an investment portfolio. All funds invested in the purchase of shares are in trust management, so the investor can only find an American or other foreign broker, open an account and purchase shares.
REITs are also attractive because they do not require a large amount of capital from a private investor. Just a few tens or hundreds of dollars, and an investor can become a happy owner of foreign real estate. Among the options for investing in a REIT, we note:
- purchase of a REIT on the NYSE, that is, on the New York Stock Exchange;
- purchase of a REIT through an ETF, that is, an exchange-traded investment fund. In our country, mutual funds are an analogue of ETFs (a form of collective investment).
- purchase of shares on the St. Petersburg Stock Exchange.
Risks and disadvantages
We should immediately note that investing in a single asset involves great risks, so experts recommend collecting a portfolio of various investment instruments. But if an investor has decided to stop at a REIT, it is wiser to buy an ETF that includes up to several dozen or hundreds of shares of various REIT funds.
Otherwise, if we compare REIT funds with company stocks and bonds, then in the first case the risks are approximately equal, in the second – such an investment will be riskier, since bonds are traditionally considered a more reliable way of investing. Of the obvious disadvantages , one can distinguish:
- the need for careful analysis when choosing a REIT. Since the investor actually buys shares, it is important to evaluate the performance of the fund, and those, by the way, are not always positive;
- management fee and possibly a fee for the right to invest in the fund;
- the need to pay taxes. In this case, since we are talking about foreign funds, the income tax is very impressive. For example, if the fund is registered in the USA, the investor will have to give 30% of the income, and in the absence of a W8BEN form, also 13% of personal income tax (applicable to citizens of the Russian Federation).
Published: 16 April, 2022