Real estate investment trust is a tax designation for publicly or privately held corporations investing in real estate. It also provides a way for the common public to invest in properties. These include commercial realty, apartments, town houses, shopping malls, warehouses, or any other type of property. These funds receive special tax considerations, offering investors a high return, and easy liquidity. It is a type of security which is traded like a stock on the major exchanges, and it invests in real estate directly. The investments are made through properties or mortgages. Investors participate in these securities because of their high dividend yields. Another benefit of this fund is that it has the potential to yield a higher income with much lesser principal.
Following are the different types of real estate investment trust.
- Equity REIT: They basically invest in properties and take the ownership. They perform the acquisition, building, renovation, and sale, and are also responsible for the equity of the same.
- Mortgage REIT: They deal in the investment and ownership of property mortgages. It is a non-taxed entity that invests in a variety of products, like lending, buying, and selling mortgage-backed securities. Their prime source of income is from the interest that they earn on mortgage loans.
- Hybrid REIT: As the name suggests, it is a combination of the above two trusts. They invest in both properties and mortgages.
The buying and selling of a REIT is similar to that of a normal stock. However, there is a basic difference in terms of financial expansion and measure of profitability. The conventional P/E (price-to-earnings) ratio may or may not apply to this fund, and investors usually look for trustworthy and competent management.
Working of a REIT
A mortgage REIT makes money by borrowing on a short-term basis and lending for the long-term. The lower interest rates in the short term mean that they are able to lend at a higher rate of interest. When the difference between the short and long term interest rates is very high, this fund can make huge profits. Whereas, an equity REIT owns or has an interest in rental properties. Their revenues come principally from their properties’ rents. The major elements for analyzing the fund performance are its net asset value (NAV), adjusted funds from operations (AFFO), and cash available for distribution (CAD).
Like any other form of investment, REITs also come along with their own share of risk. One should consult a financial expert in the field before making an investment.