Monday, 29 October 2012

Real Estate Investment Trusts: An alternative to direct property investment

Over the past few months I have gone through the pros and cons of investing in real estate and how to go about buying your own investment property and then all the things you need to know about to effectively own an investment property.

In this post I will outline an alternative to direct investment property - the Real Estate Investment Trust (commonly referred to as a REIT).    I will not cover every aspect to REITs in this post however I hope o cover some of the salient features with a few to providing more detail in future posts.

What is a REIT?

Broadly speaking, a REIT is a vehicle where several investors pool funds to invest in property.  It is essentially a managed fund which invests exclusively in real estate.

Below are some of the points which commonly define REITs (although they are not necessary for something to be classified as a REIT):
  1. There are several investors (large, or listed REITS can have thousands of investors)
  2. There is usually more than one property in the REIT
  3. They are usually structured around specific types of property (e.g. office, industrial, residential, retail etc)
  4. There is a manager who takes a management fee
Beyond these general characteristics, REITs can take on so many different forms that you can basically search for and invest in exactly the type of product you are looking for - there are listed and unlisted REITs, some of which are open ended and some of which are closed.  There are also REITs focused on growth and those focused on income and heaps of other features as well.

If you are thinking about investing in a REIT - make sure you understand exactly what you are investing in because it is not as standardised as many other financial products.

Benefits of investing in a REIT

There are several benefits associated with investing in a REIT (relative to direct property investment).  These include
  • The entry costs are much lower
    • Investing in direct property costs a lot of money up front.  This includes the amount for a deposit, taxes and a certain amount to cover the interest until the property is rented out
    • REITs do not have these costs - you generally invest a minimum amount (which can be as low as $1,000) and you get the same proportionate return as everyone else
  • Your risk is spread over several assets
    • Single asset investing is inherently risky - all your eggs are essentially tied up in one basket
    • Investing in a REIT gives you exposure to the property sector but spreads your risk among several properties - see my post on diversification
  • It requires very little effort
    • Once you decide to invest, other than keeping track of the performance of the manager and whether they are doing anything particularly dumb - you do not need to do anything
Downsides to investing in a REIT

Investing in a REIT is not the golden solution to property investing (although during times when the property market is on an upswing people assume it is).  There are several risks and downsides to investing in a REIT including
  • You have to pay a management fee
    • This fee can vary quite a lot but generally you are paying 1% - 2% of the totally amount you have invested each year for the manager to manage the portfolio - this can really add up over the long run
  • You have no control over the asset or what assets are invested in
    • When you invest in property directly you have a lot of control to make sure that the property is being looked after the way you want and that you get the property you want
    • If you let someone else do this you are hoping that they will do it right
  • You do not take as great an interest in the fundamentals of the investment as you would if you were managing the asset
    • When you have an investment property you know absolutely everything there is to know about that property - the tenants, the upcoming expenditure requirements - everything
    • Although you should keep track of your REIT investments the fact is that most people trust the manager to do it right and only look at it once a year (if at all)
    • It is quite hard to know if and when things are going wrong until it is too late

I think that REITs have a place in every investor's portfolio.  They offer access to investments that would be out of the reach for normal investors (e.g. office buildings) and at various points in the cycles can be great value.

I hold both direct property and REITs.  I use REITs to hold those property forms that I am not comfortable investing on my own - that is development properties, commercial properties and retail investments.

You May Also Be Interested In:
Investing in Real Estate - All Topics
Things to consider when investing outside your home state
Understanding your rights and obligations as a landlord
What is diversification and how does it work?

1 comment:

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