What is a REIT – REIT Primer – REIT Investing – Real Estate Investment Trust – REITs

Hi I’m Jimmy in this video. We’re going to look at real estate investment trusts or REITs for short. So we’re gonna look at the basics of what a REIT is how they’re set up how we can value them and then throughout the whole process we’re going to mention a few quick examples just to illustrate how wide ranging this type of real estate investment can really be. OK so let’s start with the very basics. What is the REIT. Well as I mentioned REIT is short for real estate investment trust. Most of the time REIT’s own and manage actual real estate properties things like apartment buildings office buildings shopping malls or shopping centers hotels maybe warehouses or data centers. And then there is some specialty types of REITs and what they do is they invest in mortgages but we’ll come back to that one in a minute. So where do REITs come from well back in 1960 the Real Estate Investment Act was passed by Congress as a way to allow for smaller investors to be able to invest in real estate without needing large sums of money. That is often needed to invest in commercial properties or large scale residential properties like apartment buildings. Well with the formation of REITs us investors can now buy a piece of a real estate investment portfolio just like we would buy a piece of a typical company with a stock. OK so beyond giving us access to larger real estate investments REITs also have some tax advantages that make the typical REIT dividend much higher than most stocks. So a company that’s setup as a REIT doesn’t have to pay any corporate income tax as long as they follow a few rules. First they have to pay out at least 90 percent of taxable profits to shareholders. Now instead of calling their payments dividends with REITs they typically call them distributions. But the case of this video I’m going to use them fairly interchangeably. So the next thing that a REIT has to do is that they have to have at least 75 percent of all of their assets in real estate or in loans backed by real estate like mortgages plus at least 75 percent of their gross income must come from real estate related activities either the interest from mortgages or rental income from actual property is just as an example. OK so there are a few main classifications for REITs. They have equity REITs and as we the probably guess equity rates invest in hard assets like apartment buildings or office buildings. So what they’re doing is they’re buying actual real estate properties. Now most REITs fall into the equity REIT category now generally equity REITs tend to focus on specific real estate investment types. So you might get a health care equity REIT like Omega Healthcare which owns nine hundred or so long term health care facilities in the United States. And basically what they do is that they buy properties from existing health care businesses and then they lease those properties back to that health care company. In theory this frees up the health care company from having to worry about managing the real estate itself. And it allows Omega to pay its 7 percent or so distribution to its shareholders or maybe it’s an equity REIT that focuses on office buildings like easterly government Properties which owns mostly office buildings that are leased to government agencies. In their case mostly federal government agencies and that real estate is ultimately what fuels their 5 percent or so dividend that they pay. Now just to be clear I’m not bringing out these companies as examples of REITs that I like. I’m just using them as an example to illustrate how wide ranging these equity REITs are. OK so now we could jump into our next type of REIT which is the mortgage REIT. And as you may guess mortgage REITs invest mostly in mortgages. So basically a mortgage REIT will own the debt. On real estate. And an example of this type of thing might be something like two harbors. And what they do is they focused mostly on the financing behind residential properties primarily using mortgage backed securities or maybe were more interested in a company like Apollo commercial real estate which as the name implies invests in commercial real estate mortgages and mortgage backed securities. Apollo has a distribution rate of about 9 or 10 percent while two harbors has an even higher dividend rate. Now the question is do we think that this type of distribution level is sustainable. Well in order to figure that out we’re going to do a deeper dive into those companies but this is an illustration of how high of REITs in general can be. When you think about how it is compared to the S&P 500 let’s say which is close to the 2 percent level. Now let’s imagine we do want to do a deeper dive into a REIT. We go ahead and value our REIT. Well the first thing that we need to know is something called the funds from operations. And this is very similar to net income for a traditional company although it’s not exactly the same thing. We could say it’s sort of like net income with some adjustments specifically for the real estate world of investing. So how do we calculate funds from operations. It’s actually quite simple. We take net income and then we subtract any profits on the sale of real estate that we have. And then we add back the losses on any real estate sales that we have. And then we add back impairment charges and then we add back any real estate related depreciation and amortization and then boom just like that we have funds from operations. Now this is important because now we have something to compare the price of the REIT to. So we can take the funds from operations. They might also call this FFO for short while we take FFO and we divide that by the number of shares outstanding. And this will give us the FFO per share. Now we can apply. We can take the price of the REIT divide it by FFO per share and just like that we have price to FFO. Now this could be very similar you could look at this in the same way that you’d look at price to earnings or PE ratio. Now we can also normalize funds from operations by removing one time charges or gains. Now many investors prefer to use something called adjusted funds from operations or AFFO for short. Well basically what that does is it tries to create something similar to free cash flow but this time for REITs now this is done by making a few more adjustments like getting rid of capital expenditures and then they adjust some accounting rules around the way rents are accounted for and new properties are accounted for. So FFO can be a great starting point and a great way to value REITs but one of the best possible ways to value a REIT is something using NAV or net asset value. Basically the goal here is to try to calculate what at least ballpark what the underlying real estate assets are actually worth. Now this can be a bit tricky to do since companies don’t report these types of numbers and this is really something that investors like to do because the theory is if we could value the actual real estate then we wait for the price to fall below that the value of that real estate. In theory we should get a great deal. So as we could see there are a lot of different ways to value REITs and a lot of different tools and tricks to analyzing them. And there are some good advantages to REITs like they tend to pay pretty good dividends and they do a pretty good job of giving us access to the real estate market even if we only have a small amount of money to invest. And it also helps us diversify our portfolio into an asset class that perhaps we wouldn’t have exposure to if this type of fund wasn’t set up. On the flip side one thing we should keep in mind about REITs is revolves around their stock issuance so many times REITs will have to do secondary stock offerings to raise additional capital since they’re paying out the majority of their profits if they ever need to make new acquisitions or clean up their balance sheet. Oftentimes they have to issue more shares to get the cash that they need and that might not always be the best thing for shareholders. So that’s something to consider at least on the negative side. Now regarding the dividends that REITs end up paying well REITs tend to have fairly stable dividend distributions and while this can be a good thing for real estate investors who are looking for a steady stream of income now that’s not to say that the value of the stock itself or the value of the REIT itself doesn’t swing around like every other stock it does. Sometimes they’re more volatile than typical stocks but their distributions tend to be fairly stable and this could be a good thing for investors who are relying on a steady stream of dividends. So that’s the basics of REITs and the some of the advantages and disadvantages of them. Now I recognize that this was a very simple look at REITs and if reads is something that you’d be interested in seeing more of. Please let me know in the comments below. Then we can either go into the industry a bit deeper that if we think that would be interesting or perhaps it would make more sense to dive right into individual REITs and get our exposure to the entire industry that way. Let me know which one you think would be more interesting and if you haven’t done so yet please hit the subscribe button. It’s the thumbs up. And I’d like to thank you for sticking with me all the way to the end of the video. I’ll see in the next video. Sorry you made this so short but I’m not sure if people are really interested in this type of thing. So if dividends from REITs is something that interest you let me know in the comments below we’ll do more extensive looks at this. Thanks and I’ll see in the next video.

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