Also known as Real Estate Investment Trust (REIT), (Equity) REITs own income-producing properties and pays a sizable cash flow to shareholders every month.
There are certainly pro’s and con’s to investing in a REIT, and investors with a sizable investment portfolio should consider investing in one.
REITs distribute over 90% of its income to shareholders every month
Because of a REITs structure, it must distribute over 90% of its income to shareholders.
This large cash payment is a reason why the yields in REITs are higher than typical dividend-paying companies. As the REIT collects rent from its tenants it passes these rents on to shareholders as a flow through.
REITs help diversify the investment portfolio
REITs have a different risk profile than most other stocks traded on the stock exchange.
REITs typically rent out its space to tenants for 5-year to even 20-year terms. This ensures cash flow certainty for REITs.
Also, REITs typically add rent escalations into its lease and this provides a bit of hedging against inflation.
The way REITs earns a return is a diversification for investors who invest heavily into more speculative investments – where cash flow and revenue are not as consistent as REITs.
REITs are an indirect way of owning real estate and someone is managing it for you
Another benefit to owning REITs is investors are landlords but without the hassle of managing the property.
When the pipes burst or the fire alarm goes off in a property, REITs have a property management company in place to deal with all of this.
Investors in a REIT are like silent equity partners where they only need to provide the investment capital and someone else will do the rest.
REITs are more liquid than owning a piece of real estate
People who have gone through the experience of buying or selling a property will understand that it typically takes at least 1 to 2 months for a real estate transaction to close.
For the seller, the property must go on the market and scheduled touring of the property will need to be arranged.
For the buyer, there is a back and forth on the purchase price, and the effort needs to be made to arrange financing (unless the buyer is paying with cash).
For REITs listed on the stock exchange, it is a simple buy-or sell order and the transaction is complete.
There are a few disadvantages though in owning REITs.
REITs rely on debt to expand
Since REITs typically pay out over 90% of its revenue to shareholders, REITs must rely on borrowing from the debt markets to grow its property portfolio.
This makes REITs very susceptible to interest rate changes. In early 2010, REITs were a boon because interest rates had been low.
More recently, interest rates (Canada and US) have been slowly creeping back up again and this has put some pressure on REIT prices.
The monthly distribution is not guaranteed
REITs have more cash flow certainty than stocks because of its tenant leases, but this doesn’t prevent tenants from filing for bankruptcy.
The real estate landscape has seen Target vacate its Canadian stores and Sears gradually close its stores across North America.
The loss in tenancy can hit the REITs bottom line and this leads to a cut in distribution. Cominar REIT (TSX:CUF.UN) had cut its distributions in late July when it was paying out more than it was taking in.
As with all publicly traded securities, REITs presents its own set of risks, but it also makes a good diversification stock to anyone’s portfolio.
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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