Categorized | Beginning Online Trading

What are real estate investment trust( REIT)?

A Real Estate Investment Trust (REIT) is a security that is traded like a stock on the stock exchange. A REIT invests in real estate assets (e.g. shopping malls, office buildings, apartments, etc) directly, through the capital that it raises from shareholders. REITs distribute a large chunk (typically over 90% of the rental income generated) back to the shareholders as dividends regularly. This rate can be found in their prospectus as the DPU, or Distributions Per Unit.

Benefits of Investing in REITs

REITs allow small, individual retail investors to venture into real estate investing other than directly investing in it themselves. This may be a better opportunity for long-term investment as it not only provides you with the chance of capital appreciation (the REIT’s price increases), but also generates regular cash flow from the dividends from the rental income.

In addition, REITs provide the investor with these two main benefits:

1) Professional Management

REITs take out the hassle and troubles of property management. Finding your own tenants and maintaining your property is now not your concern, and you’ll never get a call in the middle of the night complaining of a broken light or burst waterpipe.

2) Diversification

Unlike individual real estate investors, REITs own multi-property portfolios. This reduces the risk of relying on a single property/unit/tenant, which is the usual case with individual real estate investors.

Potential Investment Returns of a REIT

Total returns from REITs can range from 6% to 14% annually, but depend greatly on the individual REIT. Before distributions are made by the REIT, annual managers’ fees, trustees’ fees, property management fees, and other expenses will have to be deducted first.

Investment Risks of REITs

REITs have similar risks as directly investing in real estate.

1) Quality of Property Portfolio

High-quality properties in prime locations are always good, because it means that tenancy is almost guaranteed, and that dividends will be protected. Conversely, lower quality properties in less desirable locations result in poorer returns for shareholders, especially in times of economic crises.

2) Fall in Property Rentals and Prices

Changes in market conditions can cause a fall in rentals, rental income, and/or property valuations. This will affect both the value of your REIT and the dividends that you receive.

As a result, it is very important to be sure that you invest in REITs only at the right time. The adage buy low, sell high applies here. Only invest during economic downturns, or during the early period of economic recovery. This is when real estate prices are still low, and dividend yields are high. Intuitively, you should then sell, and avoid buying when property prices are high.

3) Significant Increase/decrease in Interest Rates

REITs depend on financing heavily, and financing is based on interest rates. When interest rates are high, then the financing costs to REITs increase, leading to lower earnings and subsequently, dividends. However, the converse is true when interest rates dip.

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