REITs offer opportunity, liquidity, and risk

Mailbag

January 14, 1996|By Michael Gisriel

Dear Mr. Gisriel: I am interested in possibly investing in commercial real estate, but I want to limit my downside exposure. What are REITS? Would they be a good investment vehicle for me to participate in commercial real estate? How do I go about investing in a REIT?

Tom Fisher

Baltimore

Dear Mr. Fisher: Real estate investment trusts (REITs) are similar to closed-end mutual finds in that they pool money from many investors and use professional management to oversee a portfolio of mortgages, properties, or both, depending on the objective of the fund. REITs were created through the federal Real Estate Investment Trust Act of 1960 and offer investors a way to participate in the real estate market with greater liquidity and less personal involvement than direct ownership of real estate or limited partnerships.

One of the most beneficial characteristics of REITs is the taxing of earnings at the shareholder level, rather than the corporate level, providing several tests are met. Among the most important are:

* At least 95 percent of taxable income must be distributed to shareholders.

* At least 75 percent of the assets owned by the REIT must be real estate, cash or government securities.

* At least 75 percent of the firm's revenue must come from real estate activities (rents, mortgage interest, gains from property sales).

* A REIT must have at least 100 shareholders, and not more than 50 percent of the shares can be concentrated in the hands of five or fewer shareholders.

REITs usually perform better in a falling interest-rate environment because the cost of funding acquisitions declines, and higher valuations are then placed on their relatively high yields. On the other hand, a key attribute of investing in real estate is that it may serve as a hedge against inflation, but the same forces that drive up inflation also drive up interest rates.

Consequently, potential REIT investors must balance competing factors: the higher real estate values that come with inflation versus the eventual dampening effect of higher interest rates on REIT stock valuations.

Historically, REITs have performed poorly at either extreme of the economic cycle.

An economy in recession usually leads to lower occupancy rates and more foreclosures, thus adversely affecting REITs. On the other hand, property values tend to get driven up in a rapidly expanding economy, eventually resulting in higher interest rates and a sell-off of REIT shares.

There are nine categories of equity REITs that are tracked and traded on the New York and American stock exchanges and Nasdaq: offices, shopping centers, apartments, manufactured homes, hotels, health care facilities, regional malls, industrials and outlet centers. It is important to know how each category has performed and, particularly, how well they will perform during different economic phases.

For information about specific REITs, I suggest that you consult a stockbroker familiar with REITs.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.