Investing in REITS by Ralph L. Block

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How to Successfully Invest in Real-Estate Investment Trusts

“By investing in investment-quality REITs, investors large and small have been able to earn total returns averaging 12% annually, with steady income, low market-price volatility and investment safety.”

REITs, real-estate investment trusts, have been around since the 1960s. Investors have started to see the benefits of REITs, as these entities are not affected by stock market fluctuations. They have invested approximately $300 billion in REITs – about the same amount of money invested in Microsoft. The type of REITs of interest is based on “equity” rather than “mortgage,” meaning these corporations don’t lend money for real-estate.

Though a REIT’s stock will be traded on public exchanges, it requires at least 100 shareholders with the stock widely distributed amongst them. Unlike S-corporations or C-corporations, REITs, which have to pay 90% of their net incomes to shareholders, avoid taxes. They do not have to pay a cent of corporate tax, if they pay 100% of their taxable income to shareholders. REITs present investors with much less headache, as they don’t have to constantly watch the market for opportune moments to buy and sell. Plus, REITs own and lease many different kinds of real-estate, from prisons to golf courses.

A REITs performance depends on a cyclical real-estate market. Rather than investing all your money in one type of property, spread it amongst different property forms. In 2004, approximately 25% of the money invested into REITs was specifically invested in office and industrial properties. These types of property are generally stable investments, as is retail, which makes up another 15% of REIT investments.

Rather than looking at a company’s net income, expert REIT investors look at “funds from operations” (FFO), which observes the net income before the cost of depreciation is deducted. Another measure of profitability is AFFO – adjusted FFO. AFFO takes expenses that don’t boost a property’s value into consideration.

In order to locate a REIT that can demonstrate positive FFO growth during all periods of a real-estate cycle, look for these seven attributes:

  1. “An experienced management team” – Find managers who have demonstrated good FFO gain during good and bade times.
  2. “Access to capital” – Watch to ensure gained capital is used effectively by the REIT.
  3. “A strong balance sheet” – Though debt is okay in moderation, observe the maturity of the debt and ratios of debt.
  4. “A geographic and sector focus” – What type of property or region does the REIT have most experience with.
  5. “A management team that owns stock in the REIT” – Your managers will be especially interested in the REIT’s success, if they stand to gain from said success.
  6. “Cash” – “All REITs should retain some cash.”
  7. “No conflicts of interest” – Don’t invest in a REIT infamous for purchasing expensive apartments owned by its managers.

Though REITs have some risks, just like other forms of investment, the benefits far outweigh the risks. For your money’s sake, consider these risks before investing:

  1. “Overbuilding”
  2. “High interest rates”
  3. “External funding”
  4. “Tax laws and other regulations”

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