Investment
Gareth Lane
Updated Dec 19, 2022
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This information has been reviewed by our SMSF Mates before it was published as part of our review process.
Real estate investment trusts (REITs) give you the ability to own a piece of a company which owns and runs different real estate investments. REITs (or A-REITs in Australia) are very similar to an investment fund in the sense that investors capital is grouped together to make investments on behalf of the entity. By owning a REIT, it makes it possible for investors to gain exposure to direct property investments, receive distributions and potential capital growth without having to fork out a substantial initial outlay.
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A REIT is essentially an entity which owns and runs various types of real estate investments like commercial office space, warehouses, industrial buildings, factories, shopping centres, residential buildings, apartments, hotels, hospitals and much more.
REITs are often sought after by income-seeking SMSF investors due to their ability to pay and grow their distributions to investors. As with any real estate investment, they do not come without their risk, so it’s essential to fully understand what you are investing in before taking the plunge. Understanding how to value a REIT is also important and knowing when they’re considered cheap or expensive comes into play like most other investments you would make.
For the most part, each REIT will specialise in a specific sector of the real estate sector. There are exceptions to this rule where a REIT will hold a diversified selection of commercial and residential properties (more of a property fund).
REITs are often exchange-traded meaning they are listed on the stock exchange (ASX in Australia), and investors can buy or sell them the same way they would do so with shares, and similar to a large-cap stock in terms of daily turnover or volume traded.
The first two things you need to consider before buying a REIT are:
what asset category does the REIT fall under?
where can you invest in the REIT (publicly listed and unlisted)
The three main asset categories which REITs fall under are equity REITs, mortgage REITs and a combination both called Hybrid REITs.
Equity REITs are the most common and operate very similar to how a landlord of a property would. The REIT purchases the real estate investment, and maintains the property, collects the rent from the tenants (whether it be commercial or residential) and does everything else required in the management of the property.
Mortgage REITs are a little different in the sense that they don’t own the underlying property. In contrast, they own the debt backed by the property. That is, when someone takes out a mortgage on a house, a Mortgage REIT would purchase the debt from the original lender and collect the mortgage repayments over time, while the owner of the property operates and maintains it. This kind of REIT rewards investors with higher distributions due to the increased risk they are taking on the investment.
Hybrid REITs, as the name suggests, are a combination of both equity and mortgage REITs. They own and run real estate properties as well as the commercial property mortgages in the portfolio.
Exchange-traded REITs are traded on a stock exchange similar to shares and ETFs and can be purchased easily from your Interactive Brokers or Commsec account.
There are close to 100 publicly traded A-REITs on the ASX according to Listcorp at the time of writing. When a REIT is listed on a stock exchange, they tend to have better transparency and compliance due to the standards of the exchange they are listed on. In addition, investors can enjoy greater flexibility with their investment due to the liquidity on offer, meaning they can easily buy or sell the investment with the click of a button.
Unlisted REITs are often referred to as Unlisted Property Trusts and offer investor’s units in an investment trust that holds real estate investments which are typically owned and operated by an investment manager.
Because these REITs are not listed on a stock exchange, they are highly illiquid, meaning challenging to sell, and investors are often locked in for periods of eight years or more or until the property is sold and the proceeds divided up between the investors.
Unlisted REITs are also very difficult to value until they are sold, which should be another important consideration for investors.
Unlisted REITs are usually only available to wholesale or sophisticated investors due to the higher minimum investment amounts and the lock-up period of 8 years or more. Learn more about the difference between a retail and wholesale investor here.
Investors in the sector have enjoyed decent gains in the past few years with the ASX 300 A-REIT total return index up 9.05% annualised over the past ten years, and that includes the recent price impact from the COVID situation.
Shorter-term investment returns are a little mixed, showing a -19.33% return on a rolling one-year basis, 1.96% annualised over the past three years and 4.68% annualised over the past five years. Current prices in the A-REIT sector might represent value to some investors as they are the same now as they were in 2015. Like any investment, it’s important to take a long-term view and do your research to understand the investment characteristics and risk profile properly. Here’s a snapshot of the S&P/ASX 300 A-REIT Index:
A-REIT Performance
https://eu.spindices.com/indices/equity/sp-asx-300-a-reit#overview
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REITs have had decent returns over the years, and in some cases, they have outperformed the share market. Investors commonly look to REITs as a way to gain exposure to the property market, plus they are a great way to stay diversified.
REITs pay great distributions to their investors because some are mandated to pay out at least 90% of their annual income to investors, which is why they consistently offer some of the highest yields in the market. SMSF investors in retirement phase love REITs for this reason as they provide a steady stream of income.
Exchange-traded REITs offer excellent liquidity which means they are easy to buy and sell when the time comes. Investors can easily see the value of their investment during market hours and view the available buyers and sellers of the REIT just like they could with a share price.
REITs aren’t the best growth investment due to the fact they are paying out much of their earnings to investors in the form of distributions. Some investors have highlighted that REITs are often unable to capitalise on purchasing new property when the market is down due to low cash balances due to the 90% payout requirement. They also have a tough time of raising new capital in times like the 2008 financial crisis, which in hindsight would have been a great time to buy new assets.
REITs pay out their earnings as distributions (not dividends which means they are not franked as the income that the REIT generates hasn’t yet been taxed. As the REIT itself does not pay any corporate tax, it’s essentially passing on its earnings to shareholders in the form of distributions.
Unlisted REITs are often reserved for wholesale investors, and some have high minimum investment amounts which may not be suitable for all investors. Unlisted REITs may also have higher fees to buy and sell when compared to their listed counterparts.
Unlisted REITs often have an eight-year investment term or more meaning your funds are locked up and often very difficult to get out of early. Not many investors can effectively plan for eight years down the track, so it’s worth considering if this timeframe is right for you before investing.
REITs have high levels of debt, and some are the most highly indebted companies on the market. Provided the debt can be continually serviced with long-term contracts (like leases) to reliable tenants, then most investors would take comfort in this.
General Advice Warning
