Are Real Estate Investment Trusts a sound vessel – or a sinking ship?

Are REITS (Real Estate Investment Trusts) a sound vessel – or a sinking ship?

 

REITs, or Real Estate Investment Trusts, have been hot product for investors the last few years, a sophisticated and risk-adverse method of leveraging a rising and rebounding real estate market. Simply put, REITs are companies or funds that own or finance income producing real estate, leveraging the benefits of the real estate sector without having to own – or manage – individual properties. But lately, cracks are appearing in the impenetrable hull of REITs, based on concerns and loss of profits amid Fed rate hikes. So are REITs still worth it, a safe and fruitful investments going forward?

 

REITs were first modeled after mutual funds, a hybrid investment that’s traded on major stock exchanges, sometimes as public non-listed funds, or even privately owned entities. They’ve grown precipitously in the United States, reaching every state and supporting one million U.S. jobs, and have spread to several countries across the world. 

 

REITs offer indirect real estate ownership for steady income streams and long-term capital appreciation, but with flexibility and diversification where regular property ownership fell short. REITs collect rents or sell properties for profit, regularly paying out that income as dividends to shareholders, who can pocket the income or choose to reinvest, and sell shares as they see fit for liquidity many other real estate assets don’t offer. Investors are then responsible for paying their own income taxes on the profits. Essentially, REITs allow investors to buy stock in real estate, while the fund or REIT purchases blocks of property and property shares, called Equity REITS, or mortgages with Mortgage REITs.

 

To qualify as a REIT, the company or fund must have at least 75 percent of its total assets invested in real estate, and derive at least 75 percent of its gross income from rents, profit from sales, or mortgage financing. REITS need to have at least 100 shareholders with no 5 shareholders holding more than 50 percent of shares.

 

While most REITs trade ownership stakes in apartments, hospitals, hotels, commercial property, strip malls, nursing homes, office space, storage units, student housing, and care facilities, there are also trusts that invest in mortgages or mortgage securities for residential or commercial properties. 

 

While REITS offered steady positive income streams and great returns for investors – increasing about 10 percent annually on average - over the last half decade, they’ve stumbled recently, raising concerns that they won’t translate well to a rising interest rate environment. And with the Fed assuring a series of rate hikes over the second half of this year and into 2016, dividend payouts have faltered as analysts and investors start to sour on REITs. In fact, shares of seven of the nine REITs listed on the New York Stock Exchange actually turned in negative returns this summer, a far cry from a spectacularly profitable 2014. Through June 30, that’s a 5.4 percent decline on the U.S. REIT index, and a fragile 1.23 percent gain on the Standard & Poor's 500 Index. 

 

Part of the decline in profitability is due to tangible losses caused by rising rates, as trusts with commercial and other long-term leases but adjustable financing can’t raise rents to compensate for increased expenditures. That’s why hotels, multi-family housing, and apartments are considered a safe bet as rates escalate because it’s easy to increase tenant rents periodically, offering flexibility that long term commercial properties don’t allow. But financial analysts think the market is also playing a wait-and-see game with REITs, putting caution before risk as they watch the Fed’s every move.

 

So are REITS here to stay? The most balanced advice you’ll probably read is that REITS are now showing their downside amidst these unique and temporary market circumstances. For some, buying and owning individual properties as private investors may offer far more control and long-term income potential. Or, several investors can come together to pool resources and own a few rental units together. But for those who want to park their money in real estate without every buying a garage and aren’t scared away by negative growth or stagnate income in the foreseeable future, REITs may still be a sound bet.