Real estate investment trusts (REITs) make it easy for retail investors to invest in large-scale, income-producing real estate without having to buy a house.
Real estate is a prominent asset class in the investment industry, and most investors will have significant exposure to property in their life.
Property is an alternative asset class to traditional assets such as equities, fixed income, and money markets.
The reason is that real estate returns tend to have a weak correlation with traditional asset class returns.
Therefore, real estate can help offer diversification in an investor’s portfolio.
However, there are significant drawbacks to investing in a house or a building, including:
- Physical property needs a substantial investment amount, which in most cases requires the investor to take on debt. Debt costs may prevent the investor from realising any returns for a long period.
- Costs associated with owning a physical property, such as maintenance and repairs, can be unforeseen and significant. These costs influence the returns from rental income and can even lead to losses.
- Property is an illiquid asset that can be in the market for a long time without being sold. Investors who want to sell a property quickly will have to lower their price. A deal can also carry significant transaction and transfer costs.
- Investing in a physical property gives an investor a high concentration risk. If the property turns out to be a bad investment, a significant portion of the investor’s portfolio is lost.
The good news is that you do not have to buy a house to get exposure to the property market.
Real estate investment trusts (REITs) make it easy to invest in real estate without the restraints associated with buying a physical property.
A REIT is a company that invests in real estate either by ownership, by financing real estate acquisitions, or a combination of both.
It allows individual investors to gain exposure to real estate assets that would otherwise be much too expensive to acquire, such as commercial property like business offices and retail malls.
The REIT structure eliminates many of the risks of buying a physical property and gives investors real estate type returns at a much smaller investment amount.
REIT companies are publicly traded and, therefore, have greater levels of liquidity.
Prominent REITs listed on the JSE include Fortress, Vukile Property Fund, Investec Property Fund, Growthpoint Properties, Redefine Properties, Resilient, and Hyprop Investments.
The REIT company acts as the REIT manager. It uses a pool of funds from investors and lenders to acquire a diverse portfolio of real estate assets, including distribution centres, office parks, and residential properties.
The income generated from managing these assets is then paid to investors through dividends.
By investing in a REIT, investors gain exposure to a more diverse portfolio of real estate assets that lower the concentration risk.
REITs can generate capital gains but are mostly acquired for their strong dividend returns.
South African REITs are required to pay out at least 75% of their distributional profits to be listed on the JSE, which is their gross profit minus deductions and permittable allowances.
It is, therefore, important to analyse a REITs ability to pay dividends as it will likely be the main source of returns.
REITs are an easy and less costly way for investors to get exposure to the real estate market without worrying about the properties’ maintenance and management.
It gives investors exposure to a more diverse property portfolio than buying a single physical property.
REITs are frequently traded and have high levels of liquidity, making them a good alternative to give your portfolio greater diversification benefits.