Real Estate Investment Trusts or REITs are companies that own or finance income-producing real estate spaces across a range of property sectors. Most of the REITs are traded on the stock exchanges like any other stocks. In the U.S. the Congress created REITs to allow an average investor to participate in wealth creation through cash flows of commercial real estate. Such entities often own a pool of rental properties or real estate-backed loans which usually generate rental or interest income.
How to invest in REITs
An investor can buy shares in a REIT which is listed on a stock exchange and is traded just like any other publicly available stocks. Additionally, investors can also purchase shares in a REIT exchange-traded funds or REIT ETFs and thus own a share in the rapidly growing real estate space.
Why invest in REITs
Real estate has often been one of the strongest sectors which constitute for growing long-term wealth of the investors and have been one of the best performing asset classes over the years. Investing into real estate through REITs offers several benefits to investors by way of competitive performance, liquidity, dividend-based income, less risky asset class and diversification of portfolios to include real estate which has historically delivered strong returns vs. the S&P 500 over the decades. REITs also require less work and capital than what it takes for buying a property outright.
By law, REITs are required to distribute at least 90% of their taxable income to the shareholders via dividend payouts every year to remain in compliance with the IRS regulations. Thus, REITs tend to be among those companies paying highest dividends to their shareholders. These dividends are primarily coming in from the relatively stable and predictable stream of contractual rents which are paid by the tenants who occupy the REIT properties.
How does any company qualify as a REIT?
In order to qualify as a REIT, the company must:
- Invest a minimum of 75% of its total assets in real estate.
- Earn at least 75% of its gross income from rents from property, interest on mortgages, financing real property or either from sales of real estate.
- Pay at least 90% of its taxable income in the form of shareholder dividends each year.
- Be managed by a board of directors or trustees.
- Have a minimum of 100 shareholders.
- Have no more than 50% of its shares held by five or fewer individuals.
Publicly traded REITs and REIT ETFs
As inflationary pressure continues to increase in 2022, several investors are considering investing in real estate or REITs as these asset classes are generally considered to do well in an inflationary environment. It is obvious that buying into an apartment complex or a commercial property is not very feasible for most investors which is when the publicly traded real estate investment trusts or REITs come into place and offer investors a way to buy into a share of these real estate properties similar to buying any other shares like a Tesla(TSLA) or an Apple (AAPL) on the exchange.
In 2020, the S&P 500 was down at the beginning of the year, but ended the year with gains of about 20%, however the REIT sector ETF (VNQ) was down by 5% for the year. REITs as a sector came roaring back in 2021, when the Vanguard REIT ETF was up over 40% outpacing the S&P 500 index returns of about 28% during the same period.
How did these REITs perform during the pandemic?
When the U.S. government responded to the pandemic induced lockdowns, several REITs and other publicly traded companies experienced sudden share price corrections and, in several cases, also saw significant revenue reduction on the books. In order to handle such uncertainties, several REITs during the pandemic drastically increased the cash positions on their balance sheets and continued to maintain high cash ratios as a safety net during the pandemic.
Exhibit 1: Median cash ratios for US companies in the real estate space
Source: S&P Global, Data as of March 2022
As the economy was in a recovery mode, many of these REITs steadily scaled back their cash holdings and allowed their cash ratios to normalize close to the pre-pandemic levels. At the end of 2021, both the investment grade and non-investment grade publicly traded real estate companies had lowered their cash ratios to marginally higher than their pre-Covid levels which reflects their confidence in the future as they no longer feel compelled to hoard cash to ensure sufficient liquidity.
Reduction in corporate bankruptcies is positive for REIT Landlords
As the bankruptcies in the U.S. rose to its highest levels in 2020, these figures dropped in 2021 (graph below) to the lowest levels in over a decade and continued to reduce in Q1 2022 as well. This tremendous reduction in bankruptcies is a positive news for REIT landlords who are facing fewer tenant bankruptcies as a result overall.
Exhibit 2: U.S companies’ bankruptcy filings by the years
Source: S&P Global, Data as of March 2022
REITs see a come back in 2022
After the negative returns seen in January and February this year, REITs saw a drastic recovery during last month in March with a total return generation of 4.93%. Large cap, small cap and the mid-cap REITs outperformed with gains of 6.83%, 5.48% and 5.31% respectively whereas the micro-cap REITs underperformed with a negative return of 4.3%.
Exhibit 3: U.S. REITs performance in March 2022
Source: S&P Global, March 2022
Hotels and Office REITs have remained the best performing property types for 2022
Among the different property types, Hotels (+7.10%) and Office REITs (+5.34%) remained the top-performing property types and Malls and Infrastructure REITs have been the laggards thus far in 2022 with losses of 14.51% and 13.40% respectively for 2022. However, Land and Healthcare REITs saw its strongest performance of all types of REITs with returns of 10.3% and 9.3% respectively during March 2022 and almost 87% of the total REIT Securities generated a positive total return during the same period
Exhibit 4: Returns of Average REIT property type for March 2022
Considerably higher Dividend Yields
Dividend yield is one of the most important components of a REIT’s total returns. The particularly high dividend yields of the REIT as a sector is one of the primary reasons for most investments in this space. As several REITs are currently trading at share prices below the NAVs, yields remain high for these REITs within the sector. Investors can capitalize on such high paying dividend yield REITs which we have listed below and are actively trading on our platform.
Exhibit 5: List of REITs with highest Dividend yields as of March 2022
Investing in REITs through the ETFs
The ETFs in this space offer a diversified basket of REITs which gives investors a broad exposure to investing in real estate through a single ETF holding. Investors who wish to gain exposure to real property amid the inflationary pressures can look at some of the REIT ETFs mentioned below and can get the best exposure of REITs through the ETFs listed on our platform
Exhibit 6: Best performing REIT ETFs over the past 12 months
Note* AUMs are as of April 20, 2022, Returns are as of March 2022
The Takeaway
REITs are considered to be one of the fundamentally strong asset classes across most property types and are a great inflation hedge as they are well- positioned for long-term wealth creation of investors. However, risks in terms of rising cost of capital and increase in tenant bankruptcy are likely to remain the major headwinds that investors should keep an eye on as they make their investment decisions of REITs. The higher dividend yields paid by these REIT companies is one of the most attractive investment options for investors. Additionally, their comparatively low correlation with other assets makes them an excellent portfolio diversifier which can help in reducing the overall portfolio risks and increase returns as investment in real estate has proved to have generated considerable amounts of wealth creation. Investors can allocate 20-30% of their funds to investment into REITs and REIT ETFs which are actively traded on our platform.
