Question

Reflect info about REITs, as well as on the kinds of direct and indirect investment in real estate. Can you think of any other types of real estate investment opportunities?

Answer 1

A real estate investment trust (REIT) is a company owning and typically operating real estate which generates income. Most REITs specialize in a specific real estate sector, focusing their time, energy, and funding on that particular segment of the entire real estate horizon. However, diversified and specialty REITs often hold different types of properties in their portfolios. Properties included in a REIT portfolio may include apartment complexes, data centers, health care facilities, hotels, infrastructure—in the form of fiber cables, cell towers, and energy pipelines—office buildings, retail centers, self-storage, timberland, and warehouses. One benefit of REITs for everyday investors is that they provide the opportunity to own a portion of real estate which generates dividend-based income.

To qualify as a REIT, a company must comply with certain provisions in the Internal Revenue Code. These requirements include to primarily own income-generating real estate for the long term and distribute income to shareholders. Specifically, a company must meet specific requirements including:

• Invest at least 75% of its total assets in real estate, cash or U.S. Treasurys
• Receive at least 75% of its gross income from real property rents, interest on mortgages financing the real property, or from sales of real estate
• Return a minimum of 90% percent of its taxable income in the form of shareholder dividends each year
• Have a minimum of 100 shareholders after its first year of existence
• Have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year

Other requirements including the REIT be an entity that is taxable as a corporation in the eyes of the IRS. Further, the enterprise must have the management of a board of directors or trustees.

Much like regular dividend-paying stocks, REITs are appropriate for stock market investors who want regular income, though they offer the opportunity for appreciation too. REITs allow investors into non-residential properties such as malls (about a quarter of all REITs specialize in these), health-care facilities, mortgages or office buildings. In comparison to the aforementioned types of real estate investment, REITs also are highly liquid.

Type of REIT	Holdings
Equity	Own and operate income-producing real estate
Mortgage	Provide mortgages on real property
Hybrid	Own properties and make mortgages
Publically Traded	Listing on a national exchange
Public Non-traded	Registered with the SEC bu not publically traded
Private	Work only as private placement investments

Direct real estate investing involves buying a stake in a specific property. For equity investments, this means acquiring an ownership interest in an entity that directly owns an asset such as an apartment community, shopping center or office building. Debt investing refers to capitalizing a loan that is collateralized by real estate, such as land or an existing property.

Indirect real estate investing typically involves buying shares in a fund or a publicly or privately held company. One of the common first steps for investors is to buy shares of non-traded or publicly-traded real estate investment trustModeled after mutual funds, a REIT (real estate investment trust) is a company that owns, operates or finances income-producing real estate. They allow individual investors to buy shares in commercial real estate portfolios. More (REITModeled after mutual funds, a REIT (real estate investment trust) is a company that owns, operates or finances income-producing real estate. They allow individual investors to buy shares in commercial real estate portfolio stocks. REITs are in the business of owning and managing portfolios of real estate properties. Therefore, for traditional REITs you are, in essence, investing in the operating profitability of the landlord and not directly in the underlying assets themselves.

Like the day traders who are leagues away from a buy-and-hold investor, the real estate traders are an entirely different breed from the buy-and-rent landlords. Real estate traders buy properties with the intention of holding them for a short period, often no more than three to four months, whereupon they hope to sell them for a profit. This technique is also called flipping and is based on buying properties that are either significantly undervalued or are in a very hot area.

Pure property flippers will not put any money into a property for improvements; the investment has to have the intrinsic value to turn a profit without alteration, or they won't consider it. Flipping in this manner is a short-term cash investment.

Real Estate Investment Groups

Real estate investment groups are sort of like small mutual funds for rental properties. If you want to own a rental property, but don't want the hassle of being a landlord, a real estate investment group may be the solution for you.

There are several versions of investment groups, but in the standard version, the lease is in the investor's name, and all of the units pool a portion of the rent to guard against occasional vacancies, meaning that you will receive enough to pay the mortgage even if your unit is empty. The quality of an investment group depends entirely on the company offering it.

Real Estate Limited Partnerships

A real estate limited partnership (RELP) is similar to a real estate investment group: It is an entity formed to purchase and hold a portfolio of properties, or sometimes just one property – only it is in existence for a finite number of years. An experienced property manager or real estate development firm serves as the general partner. Outside investors are then sought to provide financing for the real estate project, in exchange for a share of ownership as limited partners. They may receive periodic distributions from income generated by the RELP's properties, but the real payoff comes when the properties are sold – hopefully, at a sizeable profit – and the RELP dissolves down the road.

Real Estate Mutual Funds

Real estate mutual funds invest primarily in REITs and real estate operating companies. They provide the ability to gain diversified exposure to real estate with a relatively small amount of capital. Depending on their strategy and diversification goals, they provide investors with much broader asset selection than can be achieved in buying individual REIT stocks, along with the possibility of fewer transaction costs and commissions.  

REITs can play an important part in an investment portfolio. As with all investments, they have their advantages and disadvantages.

On the plus side, REITs are easy to buy and sell, as most trade on public exchanges. This marketable feature mitigates some of the traditional drawbacks of real estate. Traditionally, real estate is notoriously illiquidity—property can take a long time to sell or purchase—and its lack of transparency as not all markets offer reliable information on taxes, ownership, and zoning. REITs are regulated by the SEC and must file audited financial reports.

Performance-wise, REITs offer attractive risk-adjusted returns and stable cash flow. Also, a real estate presence can be good for a portfolio, diversifying it with a different asset class that can act as a counterweight to equities or bonds.

On the downside, REITs don't offer much in terms of capital appreciation. As part of their structure, they must pay 90% of income back to investors. So, only 10% of taxable income can be reinvested back into the enterprise to purchase new holdings.

Dividends received from REIT holdings are taxed as regular income. One primary risk for REITs is that they are subject to real-estate market fluctuations. Also, like most investments, don’t guarantee a profit or ensure against losses. Further, some REITs have high management and transaction fees.