Retail investors can realize numerous benefits from investing in real estate investment trusts (REITs). Dividends, protection against inflation and exposure to real estate are just a few incentives for buying in.
REITs are simple enough to invest in, you'll simply need to work with a broker or financial advisor to find the right one for you. There are also REIT exchange-trade funds (REIT ETFs) and REIT mutual funds as well.
As with any investment, REITs do carry their risks. Here are some key points to keep in mind when deciding whether or not to purchase these securities.
1. Real Estate Diversification
A major advantage to investing in REITs is accessibility. "For the average person, their primary real estate is their residence," said Michael Cuggino, portfolio manager of the Permanent Portfolio (PRPFX), a $16 billion mutual fund. "Most people aren't going to go buy a shopping mall or an office building, so they allow you to participate in various aspects of real estate which gives you broader diversification for your real estate holdings."
Cuggino emphasizes the importance of diversity for investors looking to gain REIT exposure. "Different sub-sectors of the real estate market behave differently," he said. "Just because office buildings are doing well, that doesn't mean that residential real estate is doing well. Or if warehouses are doing well, that doesn't mean that healthcare REITs are doing well."
Dividends are another key aspect for investors to keep in mind when looking at REITs. "They are good income vehicles and are a good hedge against inflation of paper money," Cuggino said. "They have provided a great total return over the years when you combine the dividend yield and the asset appreciation."
2. Dividend Income
Cuggino's sentiment on the value of dividends is echoed by Peter Sorrentino, a senior portfolio manager for Huntington Asset Advisors. "REITs are especially attractive for a retail investor," he said. "They are very useful now when it's tough to get a return on anything in the way of regular income. REITs also get the benefit of the depreciation shield."
Sorrentino notes various types of REITs can be used to add precision to an investment strategy. "You can get into different parts of an economic cycle utilizing REITs," he said. "Hotel and self-storage REITs are very early to pick up an economic cycle, because they re-price every night or once a month. So if it's early in an economic cycle you can play that type of REIT."
Regardless of the type of REIT being considered, investors should pay careful attention to valuations. "REITs have a nasty habit of blowing up once a decade," Sorrentino said. "I always caution people to not be the last person to buy into a REIT. When yields get down and prices have been hot for a while, it's best to step away from them."
3. Valuation Dynamics
In searching for the right REIT, investors are likely to encounter differing valuations based on geographic locations. "Three or four years ago we were finding tremendous opportunities in REITs in Japan," said Drew Edwards, a manager for the Advisory Research International Small Cap Value Fund (ADVIX). "REITs in Japan have since really taken off and as we look at the world today we're finding more value in pockets in Japan other than REITs."
The uptrend in valuations may be a sign that Japanese REITs have become an overcrowded play. "Investors in Japan, as in most places around the world today, are very focused on yield," Edwards said. "They've been chasing any investment that kicks off an attractive yield. A lot of investors have piled into that trade and have driven up valuations significantly."
Marco Priani, also a manager for the Advisory Research International Small Cap Value Fund, points out that REITs with sizable yields are not necessarily desirable investments. "You have to be careful," he said. "Sometimes the most attractive yields contain risk. They are yielding so much because there is fear that the company will not be able to make its payments on loans and will have to issue equity."
4. Traded vs. Non-Traded: Liquidity
If what you're looking for in this new investment is liquidity, pay careful attention to the REITs you invest in. REITs differ from other real estate investments in that if they are traded on public stock exchanges, they're much easier to make liquid because it's a simple matter of buying and selling your shares.
However, not every REIT a broker or financial/investment advisor can offer you is necessarily a publicly traded one; some brokers offer non-traded REITs. And if the REIT is a non-traded one, it is a far more illiquid asset. How long-term you plan on this investment being will go a long way in determining what it is you're looking for in a REIT. A publicly-traded one could be more of what you're looking for if it's more of a short-term investment, and even if you're looking for a long-term investment and prefer one that's more liquid.
However, non-traded REITs feature less market risk, since they're not traded on any public exchange. Publicly traded and non-traded REITs each have a lot of factors to consider; work with your broker to determine which, if any, is best for you.
5. Type of Real Estate
The location of your REIT isn't the only specific about the property you should be looking into. What type of real estate is this REIT?
Do research into how certain industries you can invest REITs in are performing before making any sorts of decisions. Many REITs are retail real estate, but if you're looking to invest during a time when shopping malls are performing poorly, perhaps look elsewhere. You'll need to do similar research if you're looking into office buildings, or healthcare buildings.
Even before looking at the specific properties/businesses you may be buying shares in, knowing the strength of the industry the real estate resides in gives you the best potential for a better, more profitable investment. Know how the industry is performing (and even more specifically how it's performing in the city the property is in) and how it is expected to perform in the future before making your decision of whether or not to invest.