REIT Round Up – Understanding Real Estate Investment Trusts
By Nate Bernstein, Esq., Managing Counsel, LA Real Estate Law Group
A real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate. REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, retail outlet centers, single use buildings, casinos, golf courses, hotels and timberlands. Some REITs engage exclusively in financing real estate.
REITs can be publicly traded on major stock exchanges or operate private as private companies. The two main types of REITs are equity REITs and mortgage REITs (mREITs). In November 2014, equity REITs were recognized as a distinct asset class in the Global Industry Classification Standard by S&P Dow Jones Indices. A real estate investment trust (REIT) is a real estate company that offers common shares to the public. In this way, an REIT stock is like any other stock that represents ownership in an operating business. An REIT has two unique features: its primary business is managing groups of income-producing properties and it must distribute most of its profits as dividends.
To qualify as an REIT with the IRS, a real estate company must agree to pay out at least 90% of its taxable profit in dividends (and fulfill additional but less important requirements). By having REIT status, a company avoids corporate income tax. A regular corporation makes a profit and pays taxes on its entire profit, and then decides how to allocate its after-tax profits between dividends and reinvestment; a REIT simply distributes all or almost all of its profits and gets to skip the taxation.
Multiple Sector Types
There are a number of different types of REITs. Some fall into a special class called mortgage REITs. These REITs make loans secured by real estate, but they do not generally own or operate real estate. Mortgage REITs require special analysis. They are finance companies that use several hedging instruments to manage their interest rate exposure.
While a handful of hybrid REITs run both real estate operations and transact in mortgage loans, most REITs focus on the “hard asset” business of real estate operations. These are called equity REITs. When you read about REITs, you are usually reading about equity REITs. Equity REITs tend to specialize in owning certain building types such as apartments, regional malls, office buildings or lodging facilities. Some are diversified and some are specialized, meaning they defy classification – such as, for example, an REIT that owns golf courses or casino properties. Some of the key financial statistics to examine the financial position and operation of a REIT are net asset value (NAV), funds from operations (FFO), and adjusted funds from operations (AFFO), and dividend yield (DY).
REITs were created in the United States after President Dwight D. Eisenhower signed Public Law 86-779, sometimes called the Cigar Excise Tax Extension of 1960. The law was enacted to give all investors the opportunity to invest in large-scale, diversified portfolios of income-producing real estate in the same way they typically invest in other asset classes – through the purchase and sale of liquid securities. The first REIT was American Realty Trust founded by Thomas J. Broyhill, cousin of Virginia U.S. Congressmen Joel Broyhill in 1961 who pushed for the creation under Eisenhower. As of January 22, 2013, American Realty Capital Trust, Inc. was acquired by Realty Income Corporation. American Realty Capital Trust, Inc. operates as a real estate investment trust. The company acquires and leases a portfolio of commercial real estate, primarily freestanding single tenant properties in the United States and Puerto Rico.
Since then, more than 30 countries around the world have established REIT regimes, with more countries in the works. The spread of the REIT approach to real estate investment around the world has also increased awareness and acceptance of investing in global real estate securities in a variety of sectors.
A comprehensive index for the REIT and global listed property market is the FTSE EPRA/Nareit Global Real Estate Index Series, which was created jointly in October 2001 by the index provider FTSE Group, Nareit and the European Public Real Estate Association (EPRA). Another online source is reitnotes.com.
As of December 2017, the global index included 477 stock exchange listed real estate companies from 35 countries representing an equity market capitalization of about $2 trillion (with approximately 78% of that total from REITs).
Evolution of the REIT Investment Vehicle
Around the time of their creation in 1960, the first REITs primarily consisted of mortgage companies. The “Avalons” of the financial world were to evolve later in time. The industry experienced significant expansion in the late 1960s and early 1970s. The growth primarily resulted from the increased use of mortgage focused REITs in land development and construction deals. The Tax Reform Act of 1976 authorized REITs to be established as corporations in addition to business trusts.
The Tax Reform Act of 1986 also impacted REITs. The legislation included new rules designed to prevent taxpayers from using partnerships to shelter their earnings from other sources. Three years later, REITs witnessed significant losses in the stock market.
Retail REIT Taubman Centers Inc. launched the modern era of REITs in 1992 with its creation of the UPREIT. In an UPREIT, the parties of an existing partnership and a REIT become partners in a new “operating partnership.” The REIT typically is the general partner and the majority owner of the operating partnership units, and the partners who contributed properties have the right to exchange their operating partnership units for REIT shares or cash. The industry struggled beginning in 2007 as the global financial crisis kicked in. In response to the global credit crisis, listed REITs responded by deleveraging (paying off debt) and re-equitizing (selling stock to get cash) their balance sheets. Listed REITs and REOCs raised $37.5 billion in 91 secondary equity offerings, nine IPOs and 37 unsecured debt offerings as investors continued to act favorably to companies strengthening their balance sheets following the credit crisis.
REIT dividends have a 100 percent payout ratio for all income at lower rates. This inhibits internal growth of the REIT and causes investors to not tolerate low or non-existent yields as the interest rates are more sensitive. Economic climates characterized by rising interest rates can cause a net negative effect on REIT shares. The dividends paid by some REITs may look less attractive when compared to bonds that have increasing coupon rates. However, some REITS pay more annual yield than bond coupons. Also, when investors shy away from REITs, it makes it difficult for management to raise additional funds to acquire more property.
Investment in Publicly Traded REITS has Certain ADVANTAGES for the Retail Investor:
Investment in publicly traded REITs may be good passive “real estate investments.” Here are the reasons:
- High Dividend Yield: REITS may pay a higher annual dividend, as compared to most dividend paying blue chip or FANG stocks. Many well-known stocks don’t pay any dividend (i.e., Meta Platforms). For example, the REIT known as Apollo Commercial Real Estate Finance (ARI) pays an annual dividend yield of 15.44 %. At least with a REIT that pays a high annual dividend, you have something of a hedge against a market downturn and have a built-in offset to a drop in price per share.
- Steady Price Per Share Range in Bull Market Conditions: During a bull market, a well-capitalized REIT, may generally not have extensive fluctuation in its price per unit (or price per share) as compared to the typical large cap stock. Financial news and economic data can impact the share prices of REITS. Some REITS tend to trade in a tight range which allows for more predictability in your investment planning. This is in comparison to many “blue chip stocks,” that can drastically fluctuate as much as 10 % to 30 %due to poor earnings reporting or poor future guidance or other bad news. For example, Kraft Heinz (KHZ) dropped 22 % in one day 2019. This year regional banks took a similar beating this year, and the tech sector dropped more than 25 % in the bear market of 2022.
- Instant Liquidity: If you do not like what the REIT price is doing on the publicly traded market, or you disagree with the approach of management- you can generally sell the security instantly on the open market in a number of seconds. Try to do that with your 30-unit apartment building or 5-bedroom rental house- it is not that easy.
- No Tenant Headaches: You do not have to deal with tenants directly. No repairs, no maintenance, or tenant complaints, no evictions. That is just a wonderful feature.
- No Direct Exposure to Litigation: You are in a sense a very, very limited “partner,” with other investors, and therefore your liability exposure to the lawsuit grind is very limited. The entity that owns the asset can be sued- but you as a retail shareholder have very limited liability for litigation related to daily real estate operations. If a tenant sues the REIT, you, as a retail investor who is not involved with day-to-day management, will not be sued and insurance will defend and indemnify the company for the loss.
- No direct risk exposure to casualty or “Act of God.”: If you own a REIT investment, as compared to an apartment complex, the investment cannot burn down or be subject to an earthquake or hurricane. If you own a building directly, it can be destroyed in a fire or earthquake or other calamity.
- Protection through Stop Loss Stock Technology: Through your trading platform (such as Schwab or Fidelity) you can set a stop loss or stop loss limit to sell the REIT automatically if the price per share goes down to a certain level during market hours. This is an important practice to prevent a big loss. The position automatically sells at or near the set stop loss price to preserve your capital.
- Safe Haven as Alternative Investment: Like utility stocks, investors tend to place money in REITS when the traditional equity markets are dropping or showing bearish signs. A REITS investment, along with utilities, provides some balance to a portfolio and a hedge against bear markets in industrial or tech stocks. REIT prices may go up when interest rates go down, but not always.
- Sector Specialization: Depending on your specific sector interest and level of understanding of investment real estate, you can invest in many different types of property sub sector- apartment buildings, retail malls, office buildings, health care properties, elderly care facilities, casino properties, hotels, and timberlands. You can also invest in REITS that provide commercial real estate financing- in that sense, indirectly, you are the mortgage lender.
DISADVANTAGES of the Publicly Traded REIT Investment for the Retail Investor:
- Drop in Price Per Share: REITS are subject to daily stock market risk and can decrease in price per share. REIT prices can drop lower or crash with the rest of the stock market. However, during any given day, certain REIT investments may not be as volatile as the average NASDAQ or NYSE stock. Still, it is highly recommended to trade REIT securities with the protection of a “stop loss” order mechanism in place. A stop loss automatically sells the security at a given price to prevent a loss beyond a certain level.
- Decrease in Dividends Yields: REIT companies may decrease quarterly dividends, pay inconsistent quarterly dividends, or not pay dividends at all due to difficult financial company circumstances or priority debt obligations. However, the better-established REITS tend to pay consistent dividends each quarter.
- Lower Trading Bull Market Gap Up Volumes: As compared to stocks REITS may trade in lower average daily volumes. Therefore, REITS will not go up in value as quickly as rocketing stocks or rocketing IPOS like Zoom or Pinterest. REITS trade within a more limited price per share range, and in that sense price per share are more conservative.
- Sensitivity to High Interest Rates: REIT stock prices can contract due to rising interest credit rates, and an aggressive federal reserve bank. As the fed raised interest rates in 2022 and 2021, REIT prices per share dropped significantly. The cost of mortgage capital virtually tripled. The companies pay more interest to service secured debt, and thus the perception is that investors receive lower returns.
- Sensitivity to Sector Specific Downturns: For example, brick and mortar retail mall REITs can suffer due to tenant bankruptcies (i.e., the demise of Circuit City, Sports Authority), online retail sales, less shopper traffic, covid pandemics, neighborhood blight, work at home trends, and being crushed giant players like Amazon. REIT prices per share adjusted when Amazon decided not to move a big corporate presence to New York City.
- Post COVID factors: REITS that own apartment complexes suffered from rent payment collection and eviction moratoriums due to covid inspired local rent control rules. Also, the hybrid “stay at home business model” has affected the demand for office space, and the decrease in demand has impacted office REITS.
Examples of REIT Dividend Income Leaders – From Investor’s Business Daily/ Schwab
Apollo Comm Real Estate (ARI) Annual Dividend Yield: 15.44 %
Sector Focus: Originates and invests in senior mortgages and mezzanine loans secured by American and European commercial real estate.
Arbor Realty Trust Inc. (ABR) Annual Dividend Yield: 14.61 %
Sector Facsimilia- family and commercial real estate lending, mezzanine, and preferred equity financing.
Avalon Bay Communities, Inc. (AVB) Annual Dividend Yield: 3.91 %
Sector Focus: Owns and manages apartment units in New England, New York City, Washington DC metropolitan area, Seattle, and California.
Blackstone Mortgage Trust (BXMT) Annual Dividend Yield: 14.16 %
Sector Focus: real estate finance company that originates senior loans collateralized by commercial real estate in North America, Europe, and Australia.
Care trust REIT(CTRE) Annual Dividend Yield: 5.67 %
Sector Focus: Acquires and leases senior housing and healthcare properties across the country to operators of all sizes.
Chimera Investment (CIM) Annual Dividend Yield: 16.49 %
Sector Focus: Acquiring residential loans, non-agency, and agency (GNMA and FNMA) residential mortgage-backed securities.
Gaming and Leisure Prop (GLP) Annual Dividend Yield: 5.59 %
Sector Focus: Portfolio of 59 gaming assets is geographically diversified across 18 states. Tenants include Penn Entertainment, Caesars Entertainment, Boyd Gaming Corporation, Casino Queen, Bally’s, and Cordis Companies.
Global Net Lease Inc. (GNL) Annual Dividend Yield: 12.74 %.
Sector Focus: Single tenant, net lease, income producing, corporate headquarters.
Independence Realty Trust (IRT) Annual Dividend Yield: 3.44 %
Sector Focus: Owns and manages apartment communities in Southeast and Midwest.
Kimco Realty (KIM) Annual Dividend Yield: 4.79 %
Sector Focus: Owner and operator of open-air, grocery-anchored shopping centers, and a growing portfolio of mixed-use assets. The company’s portfolio is primarily concentrated in the first-ring suburbs of the top major metropolitan markets, including those in high-barrier-to-entry coastal markets and rapidly expanding Sun Belt cities, with a tenant mix focused on essential, necessity-based goods and services that drive multiple shopping trips per week.
Kite Realty Group Trust (KRG) Annual Dividend Yield: 4.72 %
Sector Focus: Operating and redeveloping community and neighborhood shopping center properties.
MFA Financial (MFA) Annual Dividend Yield: 13.89 %
Sector Focus: Investing, on a leveraged basis, in residential mortgage assets, including residential mortgage-backed securities and residential whole loans.
National Retail Prop (NNN) Annual Dividend Yield: 5.07 %
Sector Focus: Long-term investors of single-tenant, freestanding retail properties
(no malls or strip centers).
National Storage Affiliates (NSA)Annual Dividend Yield: 5.12 %
Sector Focus: A self-administered, self-managed real estate investment trust, dedicated to the ownership, operation and acquisition of high-quality self-storage facilities located within high growth markets.
Omega Healthcare Inv. Inc. (OHI) Annual Dividend Yield: 9.81 %
Sector Focus: Finance sale, leaseback, construction, and renovation of senior skilled nursing facilities and assisted living facilities.
Realty Income (0) Annual Dividend Yield: 4.88 %
Sector Focus: Acquiring freestanding, single-unit properties leased to industry-leading operators under long-term, net lease agreements. Retail properties are primarily leased to clients with a service, non-discretionary and/or low price point component to their business. Additionally, we also target industrial and distribution properties leased to Fortune 1000, investment-grade rated companies.
Redwood Trust Inc. (RWT) Annual Dividend Yield: 13.81 %
Sector Focus: Specialty finance company focused on credit- sensitive investments in residential mortgages, related assets, and mortgage banking activities.
Sabra Healthcare REIT (SBRA)Annual Dividend Yield: 10.52 %
Sector Focus: Senior residential housing, skilled nursing and transitional care, specialty hospitals and other facilities.
Simon Property Group (SPG)Annual Dividend Yield: 6.56 %
Sector Focus: Ownership of premier shopping, designer outlets, dining, entertainment and mixed-use destinations in North America, Europe, and Asia.
Spirit Realty Capital (SRC)Annual Dividend Yield: 6.82 %
Sector Focus: Triple net-lease real estate investment trust (REIT) headquartered in Dallas, Texas, and an owner of income-producing, operationally essential retail, industrial, and office properties.
Vicci Properties (VICI)Annual Dividend Yield: 4.83 %
Sector Focus: Experiential real estate investment trust that owns one of the largest portfolios of market-leading gaming, hospitality, and entertainment destinations, including Caesars Palace Las Vegas, MGM Grand and the Venetian Resort Las Vegas, three of the most iconic entertainment facilities on the Las Vegas Strip. VICI Properties’ geographically diverse portfolio consists of 49 gaming facilities across the United States and Canada comprising approximately 124 million square feet and features approximately 59,300 hotel rooms and more than 450 restaurants, bars, nightclubs, and sportsbooks.
P. Carey Inc. (WPC)Annual Dividend Yield: 5.72 %
Acquisition of operationally critical, single-tenant net lease properties in North America and Europe.
I hope this article has given you a basic overview of the world of REITS such that you can contribute to a cocktail party discussion, and brag about your favorite REIT over a gin and tonic. REIT investments are not for all investors. If you enjoy dealing directly with tenants and performing repairs and maintenance, or running a management office, then REITS may be too boring for you. You can do your own additional financial research and request financial information from the REIT companies or your broker dealer. Remember the attaché from your stockbroker- “past performance is not indicative of future results.”
Sources: Wikipedia, Investopedia, and Investor’s Business Daily, Charles Schwab website.
About the Author
The author of this article, Nate Bernstein, Esq., is the Managing Counsel of LA Real Estate Law Group, and a member of the State Bar of California and his practice concentrates in the areas of complex real estate litigation, commercial litigation, employment law, and bankruptcy matters. The contact number is (818) 383-5759, and email is [email protected]. Nate Bernstein is a 30-year veteran Los Angeles real estate and business attorney and trial lawyer. Mr. Bernstein also has expertise on bankruptcy law, the federal bankruptcy court system, creditor’s rights and debtor’s bankruptcy options. He previously served as Vice President and In House trial counsel at Fidelity Title Insurance Company, a Fortune 500 company, and in house counsel at Denley Investment Management Company. Nate Bernstein created www.laquiettitleattorney.com, a leading educational resource on quiet title real estate litigation. Nate Bernstein is a local expert on real estate law and economic trends in the real estate and leasing market, business law, bankruptcy law. Nate has personally litigated more than 40 major real estate trials, and has settled more than 200 complex real estate and business cases.