What are REITs?
REITs stand for Real Estate Investment Trusts. In order to appreciate REITs, a reader needs to understand the principle of investing in a real estate asset class. Up until recently, investing in real estate was not possible unless through direct investment.
REITs are companies that are dedicated to managing, owning and operating real estate assets that produce income. Such assets can include:
- shopping centres
- offices
- warehouses
- car parks
REIT investors
Institutional investors have ownership in the large majority of commercial real estate in Australia. Such institutions include superannuation funds, insurance companies and commercial banks. Why should investors consider investing in REITs instead of direct ownership ?
Advantages of REITs
Professionally Managed Properties
In the case of direct ownership, an investor is required to look after the maintenance of a property. REITs allow investors to distance themselves from the day to day running of the property/properties as they can be managed by an industry professional that can leverage off their own funds to provide a better service.
Reduced personal risk
Under a traditional real estate investment model, if an investor wanted to invest in real estate, they would be required to take on debt to purchase a property. Either that or they would be required to sell off existing assets to fund the purchase – either result is not suitable.
A $2,500 investment in an REIT would result in the same pro-rated rewards as say a $80,000 direct investment in a property. In addition, the REIT investment would be diversified across a range of investments, rather than one single property.
Liquidity
One of the well-known disadvantages of direct real estate investment is the problem of liquidity; it is hard to shift property quickly. REITs offer far higher liquidity and prices can in fact fluctuate on a daily basis. Investors can quickly ascertain the value of their investment, unlike with a direct investment, where a daily or even weekly quote would not be possible.
An REIT would be able to quickly sell off their holdings to generate cash for other investments.
Cash flow for Retirement
REITs provide investors excellent cash flow for retirement because the cash dividends provide an income on which a retiree can live off.
Disadvantages of REITs
Volatility
Because REITs are quoted on the ASX stock market, they are more volatile than a typick ‘bricks and mortar fund’. The main reason for this is that in addition to having an asset value, they also have a fluctuating share value.
The price of an REIT may fall due to negative feelings about the property market, even in the even event of stable property market prices.
Gearing
Some REITs use leverage to increase the potential returns for their investors, resulting in both higher gains and losses.
Income not guaranteed
Past dividends/distributions cannot be guaranteed for the future, unlike say a fixed rental arrangement with direct investment
