What is a Real Estate Investment Trust (REIT)?

Real Estate Investment Trusts are companies that invest in income-generating real estate within different sectors. You could think of it like a mutual fund, which gathers money from the investors to buy REIT properties instead of stocks and bonds. These trusts allow the average investor to earn a piece of the income from giant commercial properties such as apartment complexes, offices, shopping malls, hotels, and warehouses without having to buy or manage real estate themselves.

History of Real Estate Investment Trust

The REIT idea first originated in the USA in 1960 when President Dwight D. Eisenhower signed into law legislation allowing for the creation; the rationale was simple: to democratise real estate investing. Until then, large commercial properties had only been within the reach of the very wealthy and institutions. REITs levelled the playing field by giving average investors access to income-generating real estate through the stock market.

Structure and Working of Real Estate Investment Trust

A REIT operates like a corporation but is concerned only with real estate. They are structured just like companies, where lots of investors pool their funds together to use them to buy and run or finance income-producing properties. Investors, in turn, get REIT shares much like owning a part of that company.

A REIT would primarily have 2-multi multi-parties: the shareholders and the management. Shareholders are those investors who buy the REIT’s shares, while managers are professionals who take care of property acquisition and leasing, maintenance, as well as financing. The management would see to it that the properties would be profitably run, while shareholders would have dividends from them.

Types of Real Estate Investment Trusts

Not all REITs are the same. Depending on the business model, different REITS can be classified into three main varieties: –

Equity REITs

This is the most frequently seen type of REIT. Generated income comes from the rents that it collected through properties which it owned. To illustrate, a REIT owning apartment complexes will have rents paid by the tenants and disburse such income to its shareholders. As well, they benefit from appreciation for property value.

They are structured just like companies, where lots of investors pool their funds together to use them to buy and run or finance income-producing properties. Investors, in turn, get REIT shares much like owning a part of that company.

Mortgage REITs (mREITs)

Mortgage REITs create a positive income stream by either purchasing or originating mortgages or mortgage-backed securities as a way to provide financing for real estate rather than owning properties. Their income comes from the interest earned on these financial instruments. They are often more sensitive to changes in interest rates than equity REITs.

Hybrid REIT

As the name implies, a hybrid REIT possesses features of both equity and mortgage REITs. They have two levels of revenue flow: from property ownership and from investing in mortgages, hence giving investors exposure to both rental and interest income.

A different purpose has served each type of Real Estate Investment Trust. Equity REITs are often the most stable and a growth investment option; mortgage REITs yield higher but riskier returns. Lastly, hybrid REITs are meant to include both worlds for the sake of investors looking for diversification.

How REITs Earn Income?

Right at the heart of every REIT is income generation. But how do they make money for investors?

Primarily, this would mean rental income. For an equity REIT, this means the income from rental payments from all tenants residing within the buildings under the lessee- apartments, families, offices, businesses, and mall retailers. Mortgage REITs, among others, earn their money through interest income. Their investments are in mortgages and securities relating to mortgages, receiving interest payments from the borrower. Profits have a unique relationship with interest rate changes and can widen the returns or shrink the returns depending on the movement of interest rates.

Lastly, REITs can earn income from capital appreciation. Naturally, property values have a tendency to rise over a period, with prime locations being more attractive. Whenever a REIT disposes of real estate at a price above the original acquisition cost, the sale proceeds would make a welcome contribution to shareholder return. Besides, the renovation and development of properties strategically can enhance both rental revenue and the values of REIT assets.

Benefits of Investment in Real Estate Investment Trust

One of the greatest pros of investing in REITs is the creation of passive income. REITs must distribute 90% of taxable income in the form of dividends to enable investors to have a consistent cash flow.

Another great pro would be diversification. Real estate will often act differently compared to stocks and bonds. For instance, during periods of stock market volatility, rental income from properties tends to fortify itself against emotionally driven price volatility.

Key Differences between REITs and Direct Property Investment

The two options cannot be placed together without evaluating options. 

Liquidity is one of the significant contrasting traits. Since Real Estate Investment Trusts are listed on stock exchanges, shares can be sold in a matter of seconds. On the contrary, direct real estate involves finding buyers with financing, going through an arduous, time-consuming process, and then eventually cashing in. Such a process would then give REITs the flexibility for the investor who requires quick access. 

The ownership and control of properties are another difference. If you buy a property directly, you have full control over it. You choose your tenants, renovations, rent prices, and financing.

With leverage, direct real estate is said to give higher returns on equity than REITs. Countering are the risks that directly affect them more since vacant units, damages to properties, and economic downturns can wipe profits fairly quickly.

Conclusion

A Real Estate Investment Trust (REIT) is one of the most cost-effective means of investing in property without actually buying it. REITs are income-producing properties where investors pool their money, and in return, they yield dividends. They also provide diversification and liquidity while generating income. Their equity REITs invest in and manage rental apartments and offices, mortgage REITs provide financing for loans or mortgages, and they all open different doors for building wealth.

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