Re-evaluating Real Estate: The Million Dollar Misconception
All business students have aspirations for their business lives. While some may want to own their own companies, most will be able to become part owners in companies through mediums such as the stock market. Similarly, for commercial real estate, anybody with a few hundred dollars of savings can become an investor. How, one may ask? Through a concept known as Real Estate Investment Trusts (REITs), which allow an interested investor to share in the profits of commercial real estate businesses.
In 1960, the REIT Act was signed into law by President Dwight D. Eisenhower. The logic behind this legislation was the same reasoning behind the encouragement of stock ownership: to enable the average citizen to share in the success of America’s corporations. In the case of a Real Estate Investment Trust, investors share in the benefits of the income earned from the real estate owned by the REIT without having to put up the massive amounts of capital usually required to buy real estate. Just like regular companies, REITs can be publicly or privately owned. Publicly traded REITs are stocks which can be bought or sold. Since their inception, REITs have grown in investor popularity, expanding throughout global financial markets worldwide. The growth of REITs can be seen in the increase in market capitalization, or the total value of shares outstanding of these public real estate companies. The industry has grown in size from a total market cap of almost $90 billion in 1996 to about $940 billion at the end of 2015.
How does investing in REITs compare to investing in a typical stock? When one invests in a stock, he or she is investing for the potential appreciation of the stock price and/or for the receiving of dividends from the retained earnings of the company. REITs offer the same advantages of potential share appreciation but can also be seen as a form of a fixed income security (e.g. a bond). To this end, REITs give away a percentage of their profits each year or quarter to investors. For instance, a company such as Coca-Cola offers a $1.40 dividend per share to every stockholder. Similarly, the owner of the nearby Roosevelt Field Mall, Simon Property Group, offers a far higher dividend of $6.40 per share. In general, REITs usually offer higher dividend rates than most standard companies. The average REIT yield (rate of return for the investor) is currently 4.4% versus 2.2% for the S&P 500 index (a basket of the 500 largest U.S. companies). These high dividend rates are similar to higher yields on certain corporate bonds.
There is a fundamental reason as to why REITs have higher dividend rates. In order to legally qualify as a REIT, the company must return at least 90% of its income to shareholders. Additionally, 75% of the REIT’s income must come from rent, gains on a sale of real estate, or interest. Providing the company invests and operates properties profitably, investing in REITs can provide a safe and steady income along with the potential for appreciation of the value of the shares.
Simon Property Group was previously mentioned. Along with being the largest REIT, Simon is categorized as a retail REIT. This means the company receives its revenue through rental income from its retail tenants, which occupy shopping malls and shopping outlet centers. The types of commercial property REITs encompass covers a wide variation of sectors. From Timber REITs, to Casino REITs, to Office REITs, such as the Empire State Building (which is owned by Empire State Realty Trust), they all fit under the umbrella of the REIT asset class. In fact, there are about 19 subclasses for U.S. REITs.
One might be wondering if this is a practical sector to invest ones savings in. Firstly, similar to stocks, REITs have been known to act as a hedge (or protection) for inflation. In the last 18 of 20 years, REIT dividends have outpaced the rate of inflation. Secondly, REITs have the advantages of providing a high income like a bond, while also offering a share price which can rise with the success of the economy and the business, again similar to a stock. This dual advantage can help with the diversification of one’s investments. In other words, in a given year if certain factors cause stocks and bonds to perform poorly while Equity REITs perform well, an investor who had diversified his savings and allocated a percentage of his money into REITs would have higher returns than an investor who had exclusively invested in stocks and bonds. The advantages of diversification along with the historical low correlation of REITs to other asset classes provide a great reason to consider REITs as part of one’s investment portfolio. The famous adage of “don’t put all your eggs into one basket” certainly rings true in this instance.
Real Estate has long been a staple investment for many of the world’s rich and powerful. One needs to look no further than the presumptive Republican presidential nominee, Donald Trump, to witness how he built a fortune through real estate. Owners of real estate often enjoy the tangibility of real estate. Unlike shares of Apple, owning a hotel or office building is an investment one can touch and feel. Also, having a historical performance that is superior to the broader stock market adds to this cultural allure. The obvious roadblock is that buying an office building or hotel isn’t as easy as logging on to an E*Trade account and purchasing a share of a given company. For those interested in the Real Estate or Finance industry, REITs offer a great place to start to learn about how commercial real estate is operated and valued. And for those with some extra savings, REITs provide the opportunity for individual investors to capture the returns on all types of commercial real estate, once only restricted to high net worth investors. Who knows? With enough successful REITs investments, maybe one day you will be able to fully own your own skyscraper.