REITs: Picking the One for You
In the past, we’ve talked about investing in real estate through
real estate investment trusts (REITs) to avoid buying an actual property. Although REITs avoid all of the maintenance needs associated with owning a property, you still need to be able to pick the right one. This is easier said than done, especially with the variety of REITs available to investors. Luckily, we’re going to break it down and guide you in the right direction towards picking a REIT that suits you.
The first step is to determine which kind of REIT you would prefer.
As we’ve mentioned in a previous article, there are three main kinds of REITs – equity, mortgage and hybrid REITs. Just to refresh your memory, equity REITs invest in physical properties, while mortgage REITs place claims on the proceeds from mortgages. Let’s start with the different types of equity REITs out there. These funds can invest in many different sectors, including some of the following:
Healthcare: These REITs focus their investments in properties associated with the healthcare industry. This may include real estate, such as hospitals, retirement homes or any other medical-related facilities.
Office: These REITs invest in commercial property that is used for office buildings.
Residential: Residential REITs invest in rental properties, such as apartments, condominiums and other housing.
Retail: These REITs invest in commercial property used as storefronts for retail businesses, as well as shopping malls.
Industrial: Industrial REITs focus on real estate used to support the supply chains of businesses, such as warehouses, distribution centers, manufacturing plants and more.
Hotel: REITs focusing on the hotel sector tend to invest in a variety of different types of hotels and other hospitality accommodations.
On the other hand, we have mortgage REITs which do not actually invest in physical properties. Instead, these types of REITs may engage in trading mortgage-backed securities on secondary markets, or even issue mortgages of their own. So now that we’ve presented a variety of REITs available to you, you’re probably wondering how to determine which ones are better than others.
What to consider in the evaluation of different REITs.
Without getting too technical and caught up in valuation formulas, there are some immediate attributes you should consider:
Track record of financial performance. Specifically, you will want to do some research into the fund’s ability to provide high dividend payouts and capital appreciation on its properties.
Consider the management team. Take note of the career lengths and reputation of the members on the management team. Especially with real estate, it serves to have experienced members on your team.
Quality over quantity. Focus on those REITs that invest in quality properties with quality tenants. This will help to reduce the number of future capital-consuming expenses that will cut away at the profits of the REIT.
Ensure liquidity. This typically implies REITs that are traded on a stock exchange, since you can more easily divest or invest based on personal preference. Liquidity is one of the differentiating factors between investing in actual real estate and a REIT.
Account for industry-specific factors. Be sure to consider relevant factors of those sectors that the REIT invests in which could affect the profitability of these investments. For example, since equity REITs generate income from rental payments, consider factors that could affect occupancy rates.
Valuation techniques. For those of you who want to look at the numbers, you can apply two different methods to help you evaluate the REIT. The first option is the Funds from Operation (FFO) method, which considers whether the REIT is generating enough cash to cover its dividend obligations. The second method is to apply the Net Asset Value (NVA) formula which presents the overall value of the asset. We will explore these in further detail later on in a subsequent article.
A final option if you still don’t know which one is the one for you.
If in the end, if you just don’t feel comfortable picking a single REIT to invest in, that’s perfectly fine too. There are still other options for you to benefit from. Specifically, you can invest in index funds, mutual funds or exchange traded funds (ETFs) that invest in REITs. That way, all you do is invest in the fund and they take care of which REITs are most worthy of your capital. An added bonus is that you benefit from the diversification across many REITs.
All it comes down to is finding the investment option that’s best for you.
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