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Compared to other asset classes, property has always been a tricky one - and if I’m honest, it was never something I particularly wanted to get too involved with. The upkeep of a property and the fact that I’m not very good with DIY meant it was pretty much off limits for me!

And now, thanks to rising interest rates, property as an investment opportunity is also less attractive for many investors.

But… there is a way to invest in property without the hassle of actually buying any property at all. This financial investment is called a Real Estate Investment Trust or REIT for short. And that’s the topic of this edition of Concepts of Finance.

I’ll cover:

• What are Real Estate Investment Trusts?
• Key terminology
• 📹explanation
• A step by step guide using real examples
• Useful tools and resources

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Quickly explained

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A Real Estate Investment Trust (REIT) is a type of company that owns, operates, or finances income-generating real estate across a range of property sectors. Essentially, it allows individual investors to earn a share of the income produced through real estate ownership without having to actually buy, manage, or finance any properties themselves.

It’s like investing in the stock of a company. You’re still a shareholder but instead of owning a share of a single company listed on the stock market, you’re investing in a company that then invests in properties on your behalf.

A REIT can own a variety of real estate which can include things like office and apartment buildings or larger real estate like shopping malls and hotels. An estimated 145 million US investors own REITs either directly or indirectly through their retirement or savings funds.

The goal of the REIT is to return as much back to investors as possible. In fact, REITs are legally required to pay back 90% of their profits as dividends to shareholders - more on that later.

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The 2 main types of REITs

REITs typically fall into 2 key categories: Equity REITs and mortgage REITs. Before buying any shares in a REIT it’s important to understand which one is which up front because there are some major differences between the two.

In a nutshell, equity REITs own the real estate and pass on the profits back to investors. Mortgage REITs instead loan money to property developers and earn interest off of the money loaned.

It can be a bit confusing but if you want some more details, here’s a summary of the main differences between the two:

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The most common REITs are equity REITs and we’ll focus on those in more detail.

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REITs explained in 1 minute or less

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Benefits of investing in a REIT

REITs tend to be highly liquid; this means they can be bought or sold easily. Just like company stocks, publicly traded REITs are listed on stock exchanges which means it’s super easy for an investor to buy or sell their REIT investments. If you compare that to a standard property investment, where the buying and selling process can take months (or even years!), it’s easy to understand why REITs are an attractive potential investment.

The other major benefit of REITs is their income generating potential. I previously covered dividends (if you missed that, check it out here) and REITs are similar to dividend paying companies. This is because REITs are legally required to distribute at least 90% of their taxable income to shareholders which means that the dividend yield is often higher when compared to other stocks.

Other upsides:

• 🍱Diversification: Investing in a REIT allows investors to diversify their investment portfolios. Real estate often has a low correlation with other asset classes, like stocks and bonds, which means it can help reduce overall portfolio risk and volatility.
• 🏢Access to Commercial Real Estate: REITs give individual investors access to commercial properties, such as shopping malls, office buildings, apartments, and hospitals, which might be otherwise inaccessible due to high capital requirements.
• 📈Inflation Hedge: Real estate often serves as a hedge against inflation. Property values and rental incomes typically increase during inflationary periods, potentially providing higher returns to REIT investors.

How REITs compare to other investment types

It’s not always easy to compare different asset types since they each have their own distinct advantages and disadvantages but here’s a quick overview of some of the differences between REITs and other investment types.

Compared to individual stocks, REITs often pay higher dividends but this can mean less growth over a longer period of time vs stocks.

Compared to ETFs, REITs are (as you’d expect!) limited to real estate only. ETFs can cover a wide range of sectors and assets but REITs are real estate focused.

Compared to owning physical real estate, REITs don’t require as much direct investment up front (since you’re just buying ‘shares’ and not the property itself), but direct ownership might offer better higher potential income as the property can appreciate in value.

How to invest in a REIT

Just like stocks, most of the time, all you need to get started with investing in a REIT is a trading account at a brokerage firm. If you’ve never set one up before, typically all you’d need is some documentation to prove your identity (as you might with a bank account) and you’re set up within a few days.

Here are some of the top REITs based on the number of assets under management:

1. Prologis (NYSE: PLD): a leading industrial real estate company with a market cap of $116.4B and a dividend yield of 3.12%, specializing in warehouses and distribution centers.
2. American Tower (NYSE: AMT): Operating in the communications sector with a market cap of $109.8B and a 2.38% dividend yield, focusing on wireless and broadcast towers.
3. Crown Castle (NYSE: CCI): specializes in communications infrastructure, with a $76.8B market cap and a 3.35% dividend yield, primarily dealing with cell towers and fiber.
4. Public Storage (NYSE: PSA): a market leader in self-storage with a market cap of $65.9B and a dividend yield of 2.14%, offering storage units across the U.S.
5. Equinix (NYSE: EQIX): valued at $64.4B with a 1.74% dividend yield, Equinix specializes in data centers and internet connection services.

I’ve ranked the list based on assets under management but that doesn’t necessarily mean that’s the best way to assess a REIT as a potential investment - as always, it’s critical to do your own research!

And if you are doing your own research, there are a bunch of factors to consider. As well as the type of REIT (mortgage vs equity), take into account:

1. Interest rates - Understand how changes in interest rates could impact the REIT, particularly important for mortgage REITs.
2. Dividend yield and payout ratio - how often are payouts happening? Check the dividend history and payout ratio to assess sustainability and potential income.
3. Sector focus - REITs often specialize in specific sectors (e.g., commercial, residential, healthcare). Consider the sector's current and future prospects. Commercial real estate has been hit badly since Covid 19 for example and real estate specialising in logistics and supply chains might do better as ecommerce grows.

A real world example

Before we finish up, I thought it might be helpful to have a look at a real world example together.

Let’s imagine you decide to invest in a REIT and we’ll use Prologis as an example. has a dividend yield of 3.12%.

We decide to invest an initial $1000 and $100 every month for 10 years.

This means we’d invest a total of $13,000 over 10 years. Working on the assumption of a dividend yield of 3.1%, the estimated value of your investment in the Prologis REIT after 10 years (with an initial investment of $1,000 and monthly contributions of $100) would be approximately $15,409.86.

Not bad, but when you think about the potential gains you might get from an ETF or an individual stock that outperforms the market, it could be seen as more of a steady bet thanks to the dividends you receive.

Key terminology you need to know

• Dividend yield: This is the ratio of a company's annual dividend compared to its share price. Since REITs are required to distribute at least 90% of their taxable income to shareholders, the dividend yield is a crucial metric for evaluating REIT performance.
• Funds From Operations (FFO): FFO is a measure of a REIT's operating performance. It adds depreciation and amortization to earnings, excluding gains or losses from property sales. FFO is a better indicator of a REIT's performance than traditional earnings metrics.
• Net Asset Value (NAV): This represents the total value of a REIT's assets minus its liabilities. NAV per share gives investors an idea of the underlying value of the REIT's assets on a per-share basis, helping to assess whether the REIT is over or under-valued in the market.

⚒️Useful tools and resources

• Companies market cap REITs list - top ranked REITs you can filter by market cap and price
• A deep explanation from Investopedia
• REIT.com Industry News - a blog providing analysis of the fundamentals that impact REITs
• Dividend calculator for calculating potential returns

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I hope this was a useful guide into REITS.

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Jason

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DISCLAIMER: None of this is financial advice. Finbrain is strictly for educational purposes.