Real Estate Investment Trusts or REITs are commonly talked about by real estate and stock market investors alike. However, for most people REITs remain far less understood than traditional stock market and real estate investing. Today I’m going to explain REITs to give you an understanding of what exactly they are and if they can help you on your journey to financial independence.
REITs are corporations that own and actively manage a portfolio of real estate properties and mortgages. These properties are typically commercial properties such as shopping centres or hotels. REITs are traded on the ASX and can be purchased like ETFs, LIC and shares through a brokerage account.
Due to being traded on the ASX, REITs offer investors an opportunity to invest in the real-estate without having to physically purchase a house or save up for a 20% deposit. Similarly, as the fund is managed, investors in REITs do not have to worry about the responsibilities that come with being a landlord. At the end of the financial year, most REITs pay the majority of their taxable income to their shareholders in the form of a dividend. There are two common types of REITs offered in Australia – Equity and Mortgage REITs
Equity REITs invest in and own properties. They generate their income by collecting rent from tenants who have leased their properties. These REITs can specialise in specific property types such as hotels and shopping centres or they can diversify and hold a multitude of different property types.
Mortgage REITs generate income through loaning money to owners of real-estate in the form of mortgages and mortgage-backed securities. Whereas Equity REITs generate their income from rent, Mortgage REITs generate income through the interest paid back on the mortgages that are issued.
An obvious advantage of REITs is that they offer potential real estate investors a cost-efficient way of entering the property market. While traditionally, real estate investing involves saving a 20% housing deposit and acquiring a mortgage, REITs offer the exposure to real estate investing without the need for the deposit or mortgage. Currently, you can invest in REITs with as little as $500, making it a lot more accessible for beginner investors.
Convenience is another significant benefit of investing in REITs over acquiring an investment property. Due to REITs already being a managed fund, you bypass the responsibilities of becoming a landlord, while still being able to generate an income through the collected rent which is distributed in the form of dividends. This eliminates the stress of trying to find and maintain good tenants, responding to call-outs at 2 AM to fix unexpected plumbing issues and having to worry about extensive tax reporting obligations. The management fee that you pay entails all of these issues so that you don’t have to worry about them.
Liquidity isn’t a term most would consider with investing in real estate. It can take months or even years to sell a house after all depending on how the property market is performing. However, as REITs are traded on the ASX, you can sell them during trading hours, making them a higher liquid asset than traditional real estate.
REITs contain a portfolio of multiple property investments. For that reason, you are already more diversified with a REIT than you would be purchasing one investment property. Subsequently, your investment can be a lot less volatile than traditional real estate investments, as you don’t have all of your eggs in one basket.
REITs can have substantial management expense ratios (MER) of 1% upwards. This can eat away at your potential profit margins as you can be spending 1% of your portfolio on management costs.
While this may be seen as a benefit to some, you have no control over the physical properties themselves, as management takes this responsibility entirely. If you are a hands-on person or enjoy renovating houses, for example, this can be detrimental, as you can’t add value through your own intervention.
While REITs can offer modest returns for investors and are a viable way of diversifying an investment portfolio, they typically underperform when compared to other asset classes. LICs which can have equally as high management fees typically will provide much larger dividend yields. Whereas ETFs which have minimal management fees will often provide much larger capital gains. Subsequently, REITs are generally more tailored to real estate investors than asset investors.
If there is a housing crisis or another downturn on the property market, your REIT will likely feel the full brunt of that force as it is only investing in property. Subsequently, even though a REIT is more diversified than an individual investment property, you can still see substantial losses during a property market downturn.
REITs offer a cost-efficient way for people to invest in real estate without having many of the responsibilities that come with real estate ownership, such as being a landlord. They also bypass the need for real estate investors to have to save substantial deposit amounts or to go into debt through mortgages. With REITs being diversified and highly liquid assets, they also mitigate some risk when compared to traditional investment properties. However, their high management fees, the lack of hands-on interaction with the properties and other asset classes outperforming REITs may deter some investors.
There are several investing options available on the ASX. These include ETFs, Shares, LICs and Reits among others. If you are looking for more information on these investing options, I have attached some easy to read guides below:
If you would like to invest in REITs, I recommend using SelfWealth. As it offers the lowest flat-rate brokerage fees among any CHESS-sponsored trading platform in Australia. For more information, you can find my in-depth review on SelfWealth Here.
If you would like to sign up and receive 5 free trades during your first month, you can also use my referral link.