Explainer: What are REITs? (Real Estate Investment Trusts)

What is a REIT?

REITs, or real estate investment trusts, provide investors exposure to the property market through their stock portfolio. Similar to managed funds, REITs are actively managed and pool together investors’ money to invest in properties. REITs typically invest in commercial properties such as offices and apartment buildings, shopping centres and hotels. In Australia, REITs are known as A-REITs, and they are traded on the ASX. Generally, the minimum initial investment for an A-REIT is $500.

Two types of REITs

There are two main types of REITs.

• Equity REITs: more common of the two, equity REITs invest in and own properties. Typically, equity REITs generate their income through leasing out their properties and collecting rent. They can specialise in owning certain building types, such as hotels, shopping centres and apartments, or they can be diversified.
• Mortgage REITs: involved in the investment and ownership of property mortgages. These types of REITs loan money to the owners of real estate for mortgages or mortgage-backed securities. Typically, mortgage REITs generate income through the interest paid on the loan.

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Possible benefits

There are a number of reasons some investors are drawn to REITs. Through REITs, investors are able to earn a share of the income generated by tenants and capital growth, without having to purchase the physical property. Generally, REITs also pay out close to all of their taxable income as dividends to their shareholders. Therefore, providing an alternative income stream for investors.

Another key benefit of a REIT is that they are traded on the stock market – you can buy or sell them during trading hours. Therefore, REITs are typically a highly liquid asset, particularly when compared to traditional real estate investing. REITs tend to be a diversified investment option as well, as they provide exposure to different parts of the property market.

Risks of investing in REITs

Before investing in REITs there are a number of risk involved that you will need to consider. Similar to a managed fund, it is vital to do your due diligence and examine the management team behind the investment. Be sure to look at the level of debt a trust holds.

Another consideration is development risk. For example, if your REIT is planning to build a new building then you should consider their ability to lease out the property. Finally, a downturn in the property market will likely affect the value of your REIT, which was the case during the GFC where the REITs sector fell substantially.

Know what you’re investing in

Although not suitable for everyone, REITs can provide exposure to the property market which otherwise can be difficult to obtain. They also offer an income stream that can be attractive in a low yield environment. As is the case with all investments, it is important to research exactly what you’re investing in. Specifically, with REITs, be sure to check the dividend payout ratio. This ratio calculates the proportion of a company’s profits that are paid out as dividends. Also, look into any instances where a REIT is borrowing to acquire properties.

To learn more about how to invest in REITs and see which ones are available on the Australian market, you can visit the ASX website or speak to your stockbroker.

What about investing in property directly?

If REITs are not the right investment option for your risk tolerance, portfolio or investment goals, it could be worth considering how investing in property directly could suit you. Check out this article on how to get started investing in property.

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