REAL ESTATE INVESTMENT TRUST (REIT): Challenges and Opportunities
The REIT industry has a diverse profile, which offers many alternative investment opportunities to investors. REITs often are classified in one of three categories: equity, mortgage or hybrid.
The abundance of investment vehicles out there creates a challenge for the average investor trying to grasp what they’re all about. Stocks are the mainstay of investing, bonds have always been the safe place to park your money, options have increased leverage for speculators, and mutual funds are considered one of the easiest vehicles for investors. One type of investment that doesn’t quite fall into these categories and is often overlooked is the real estate investment trust, or REIT.
So what exactly is a REIT? Well, it’s a trust company that accumulates a pool of money, through an initial public offering (IPO), which iPO is identical to any other security offering with many of the sams then used to buy, develop, manage and sell assets in real estate. The Ie rules regarding prospectuses, reporting requirements and regulations; however, instead of purchasing stock in a single company, the owner of one REIT unit is buying a portion of a managed pool of real estate. This pool of real estate then generates income through renting, leasing and selling of property and distributes it directly to the REIT holder on a regular basis REIT – An Introduction: REIT is a real estate company that offers common shares to the public. In this way, a REIT stock is similar to any other stock that represents ownership in an operating business. But a REIT has two unique features:
a. Its primary business is managing groups of incomeproducing properties.
b. It must distribute most of its profits as dividends.
Essentially, REITs are the same as stocks, only the business they are engaged in is different than what is commonly referred to as “stocks” by most folks. Common stocks are ownership shares generally in manufacturing or service businesses. REITs shares on the other hand are the same, just engaged in the holding of an asset for rental, rather than producing a manufactured product. In both cases, though, the shareholder is paid what is left over after business expenses, interest/principal, and preferred shareholders’ dividends are paid. Common stockholders are always last in line, and their earnings are highly variable because of this. Also, because their returns are so unpredictable, common shareholders demand a higher expected rate of return than lenders (bondholders). This is why equity financing is the highest-cost form of financing for any corporation, whether the corporation be a REIT or manufacturing firm.
Characteristics of an REIT:
To qualify as a REIT, the requirements are different for different nations.
The requirement to qualify as a REIT in USA is:
a. A company must distribute at least 90 percent of its taxable income to its shareholders annually. A company that qualifies as a REIT is permitted to deduct dividends paid to its shareholders from its corporate taxable income.
b. By having REIT status, a company avoids corporate income tax. A regular corporation makes a profit and pays taxes on the entire profits, and then decides how to allocate its aftertax profits between dividends and reinvestment; but a REIT simply distributes all or almost all of its profits and gets to skip the taxation. Types of REITs : The REIT industry has a diverse profile, which offers many alternative investment opportunities to investors. REITs often are classified in one of three categories: equity, mortgage or hybrid. a. Equity REIT Equity REITs own and operate income-producing real estate. Equity REITs increasingly have become primarily real estate operating companies that engage in a wide range of real estate activities, including leasing, development of real property and tenant services. One major distinction between REITs and other real estate companies is that a REIT must acquire and develop its properties primarily to operate them as part of its own portfolio rather than to resell them once they are developed. b. Mortgage REIT Mortgage REITs lend money directly to real estate owners and operators or extend credit indirectly through the acquisition of loans or mortgage-backed securities. Today’s mortgage REITs generally extend mortgage credit only on existing properties. Many modern mortgage REITs also manage their interest rate risk using securitized mortgage investments and dynamic hedging techniques. c. Hybrid REIT As the name suggests, a hybrid REIT both owns properties and makes loans to real estate owners and operators. Structure of REITs REITs are typically structured in one of three ways: Tradi- tional, UPREIT and DownREIT. A traditional REIT is one that owns its assets directly rather than through an operating partnership.
In the typical UPREIT, the partners of an Existing Partnership and REIT become partners in a new partnership termed the Operating Partnership. For their respective interests in the Operating Partnership (“Units”), the partners contribute the properties from the Existing Partnership and the REIT contributes the cash. The REIT typically is the general partner and the majority owner of the Operating Partnership Units.
After a period of time (often one year), the partners may enjoy the same liquidity of the REIT shareholders by tendering their Units for either cash or REIT shares (at the option of the REIT or Operating Partnership). This conversion may result in the partners incurring the tax deferred at the UPREIT’s formation. The Unit holders may tender their Units over a period of time, thereby spreading out such tax. In addition, when a partner holds the Units until death, the estate tax rules operate in such a way as to provide that the beneficiaries may tender the Units for cash or REIT shares without paying income taxes.
A DownREIT is structured much like an UPREIT, but the REIT owns and operates prop- erties other than its interest in a controlled partnership that owns and operates separate properties. Advantages of REIT: a. Creates a safety net for the Investors: When you buy a share of a REIT, you are essentially buying a physical asset with a long expected life span and potential for income through rent and property appreciation. This contrasts common stocks where investors are buying the right to participate in the profitability of the company through ownership. When purchasing a REIT, one is not only taking a real stake in the ownership of property via increases and decreases in value, but one is also participating in the income generated by the property. This creates a bit of a safety net for investors as they will always have rights to the property underlying the trust while enjoying the benefits of their income.
b. Another advantage that this product provides to the average investor is the ability to invest in real estate without the normally associated large capital and labor requirements. When buying a REIT, the capital investment is limited to the price of the unit, the amount of labor invested is constrained to the amount of research needed to make the right investment, and the shares are liquid on regular stock exchanges.
c. Furthermore, as the funds of this trust are pooled together, a greater amount of diversification is generated as the trust companies are able to buy numerous properties and reduce the negative effects of problems with a single asset. Status of REITs in India: REITs are not presently operating in India but are expected to come into force soon. SEBI had invited suggestions and objection and one can have on their website. Implementing REITs would require a number of sub- stantial measures on the industry side as well as on the fiscal side. Some of the decisions pending on REITs in India are:
1. Ownership: The persons who can form REIT’s
2. The type of scheme: Open ended or close ended
3. Legal Issues: Issues relating uniform stamp duty, clear titles etc. 4. Valuations of Property With the government over the years having shown a keen desire to propel growth in the real estate sector by offering several tax and other fiscal benefits to developers and end users, we believe that such easing of restrictions and, moreover, increasing regulatory acceptance can be taken as an indication of REITS seeing the light of day in India. Expectations from Gov
ernment’s Side: To begin, with an exclusive stock exchange could be set up under Securities and Exchange Board of India (SEBI) guidelines for trading real estate stocks. The Government should permit the setting up of a Real Estate Investment Trust (REIT) which should be regulated by SEBI in order to open the investment floodgate for the real estate sector. The REIT would operate like a mutual fund, where investments of individual investors are consolidated to invest in real estate, rather than stocks of companies. It would provide a higher level of liquidity as well as professional advice for price discovery, as the investor would be investing through an asset management company. It also provides assured returns in the form of dividends to its investors from rental income earned on real estate assets. The essential difference between a REIT and a mutual fund is that investments made in REIT are traded in real estate stocks and not invested in stock of companies. Further the swings in this market are in the range of 5-10 per cent, which an average investor is in a better position to absorb than the 6090 per cent swings on the stock market.