REITS, How To Profit From Real Estate

If you want to invest in property without investing in bricks and mortar, you should consider investing in real estate investment trusts (REITs).

What Is A REIT?

US Congress introduced the REIT Act legislation in 1960 as an amendment to the Cigar Excise Tax Extension. It provided a way for the average Joe and wealthier investors to invest in commercial real estate.

REITs are companies that invest in properties such as apartment blocks, hotels, warehouses, shopping centres and offices.

They are similar to mutual funds in that they pool investors’ funds to buy the properties. They distribute the rental income from the real estate to shareholders as dividends.

You can buy and sell REITs on the stock market similar to shares. This means that REITs, unlike bricks and mortar properties, are very liquid.

How Does A Company Qualify As A REIT?

A company qualifies as a REIT in the UK when:

a) 75% or more of profits are from rental income of properties

b) and 75% of the company’s assets must be in renting property.

REITs must pay 90% of their rental income to investors as dividends making it a good source of regular income.

How To Invest In A REIT and What To Consider

You can buy a REIT on the stock market similar to a share. You can invest in:

• an individual REIT: e.g. AEW UK REIT (AEWU), founded in 2015 and its HQ is in London, UK. It invests in smaller commercial properties on shorter occupational leases in the UK. It has a market capitalisation of £154.78m and its yield is 8.21%.
• a REIT mutual fund or Exchange Traded Fund (ETF): e.g. iShares UK Property UCITS ETF (IUKP) was founded in 2007. The issuer is Blackrock. This fund focuses on total return, taking into account income and capital returns. It tracks the return of the FTSE EPRA/Nareit UK Index. The Index measures the performance of UK-listed REITs and Real Estate Holding and Development companies which meet the FTSE’s size, liquidity and free-float criteria.

The chart below shows IUKP’s top 10 holdings by weighting.

You can open a brokerage account and trade in an ISA, SIPP or taxable fund and share account.

The Pros of Investing in REITs

Diversification: Investing in REITs helps diversify your portfolio as you are investing in another asset class, therefore, potentially reducing your overall risk.

Barriers to entry are low: You can invest in real estate with relatively little money. Compare this to investing in physical real estate where you need to pay a deposit upfront to secure the property and you pay fees to:

• your lawyer
• mortgage broker
• estate agent
• surveyor.

Liquidity: Unlike physical property, REITs are very liquid. You can buy and sell them like a share on the stockmarket which means you can get your money in a matter of days if need be. Compare that to selling a property where you may wait months or even years for a buyer. Even when you get a buyer the conveyancing process can take 4 months to complete.

Regular Income: REITs are obliged by law to pay out 90% of their income as dividends. This can provide a steady stream of income for you. You can argue that you can get a regular stream of income from physical rental property which is true unless the tenant stops paying!

Potential Growth: The underlying properties in the REIT may increase in price, thereby increasing the value of the REIT.

The Risks of Investing in REITs

Concentrated Industry: Your investment is concentrated on one industry – property. Economic changes such as a recession or a tax policy change could negatively impact the industry and therefore your investment in the REIT. This could lower the share price of the REIT and result in lower or no dividends being paid out to you as the shareholder.

Low Growth: Given that REITs must pay 90% of their profits to investors as dividends, they may have little capital left to reinvest to upgrade and refurbish their properties or purchase new ones thereby limiting their growth potential.

No control over returns: If you invest in physical property, you choose the property type and size, the location, the tenants, and the amount of rent charged etc. If you invest in a REIT however, you have no control over any of these. Therefore, you are relying on the REIT management team to do this.

Interest Rates: Property prices may be adversely affected by an increase in interest rates. The cost of the mortgage repayments may go up if the interest rate is not fixed. Also, as mortgage rates go up property prices may decrease potentially affecting the value of the REIT.

Tax: Property Income Distributions (PIDs) are taxable in the UK (unless you invest in an ISA or a SIPP); 20% basic rate, 40% for higher rate taxpayers and 50% for additional rate taxpayers. (For more information see Taxation of Property Income Distributions.) This will reduce the net returns on REIT investments, in particular if you are a higher-rate taxpayer.

REITs vs FTSE 100 and S&P 500

Let’s take a look at a couple of REITs and compare their performance to the FTSE 100 and S&P 500.

British Land Company PLC (BLND.L) was founded in 1856 and its HQ is in London, UK. It is listed on the London Stock Exchange. It has a market capitalisation of £3.49bn and has approximately 927.7m shares in issue. This REIT owns and manages a portfolio of office, retail, and mixed-use properties across London and the UK. 

Land Securities Group PLC (LAND.L) was founded in 1944. It is listed on the London Stock Exchange. It has a market capitalisation of £4.78bn and has approximately 744.86m shares in issue. This REIT is the largest commercial property company in the UK, with a portfolio of office, retail, leisure, and residential assets. 

REITs Performance vs S&P 500 and FTSE 100

You can see that over the past 5 years, the S&P 500 and the FTSE 100 have both outperformed the two REITs. Over 5 years, the returns have been:

S&P 500: +73.47%

FTSE 100: +9.42%

Land Securities Group Plc: -24.22%

British Land Company Plc: -33.73%

You can see from this chart that the REITs dropped in March 2020 when Covid-19 hit. Most people were forced to work from home or stay home due to the global pandemic. This hit commercial property hard as no-one was going into the office causing a sharp drop in demand for commercial real estate.

Since then there has been a move from home/remote working to mainly hybrid working prolonging the dampening of demand for the commercial property market.

In addition, as inflation soared in the UK, the Bank of England continued to increase the base rate which resulted in increasingly higher mortgage interest rates.

The increase in rates means that mortgage debt repayments increased and made the purchase of commercial property even less attractive. This in turn has negatively impacted the performance of the REITs. However, they are both still paying healthy dividends with British Land Company Plc paying 6.3% and Land Securities Group Plc paying 6.1% (Source: Dividendmax.com).

In Summary

If you don’t want to buy physical properties or you want to but don’t have the funds to purchase a property then investing in REITs is a way to gain exposure to the real estate market either by investing in an individual REIT, an ETF or a mutual fund.

There are pros and cons to investing in REITs. So, always do your due diligence before investing.

Thanks for reading!

Have you invested in REITs or are you considering investing in them? Share your comments or questions in the Comments section below.

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