REIT Investment – Apartment Investing
REIT Investment: Real Estate Investment Trusts
A REIT Investment is a diversified and professionally managed portfolio of real estate assets that enables investors to access a property portfolio. REITs may either invest in property locally in Australia or internationally.
Any prospects of investing in office buildings, hotels, and shopping centers by an individual investor seem nearly impossible. However, these investments are more attainable than you may think thanks to real estate investment trusts (REITs) listed on the Australian Stock Exchange (ASX).
A REITs sole purpose is to invest in groups of professionally managed properties such as office buildings, apartment complexes, medical complexes, industrial buildings, hospitals, commercial forests, and so on.
Investors can gain the benefit of any increase in value in the underlying asset and from the regular rental income generated from the properties owned. REIT performance has varied over the years, but the total annual return for the past 10 years has been 10.5%.
REIT Investment Appeal
REITs offer an array of advantages to investors, including:
Investors turn to REITs and their good dividend-paying potential for diversification against future market downturns because REITs are uncorrelated with equity markets.
Each REIT and its property investments are overseen with their own management team, saving investors tremendous time from researching each property’s management team.
Property trusts, such as Real Estate Investment Trusts (REITs), do not pay corporate income tax on passive rental income but distribute this to investors who pay tax at their own individual tax rate.
Inflation protection – Since landlords are inclined to raise rents more quickly when inflation picks up, equity REITs – which obtain most of their income from rents – can be an inflation hedge.
Weighing Out Some Risks
Just like all investments, REITs carry with them specific risks that you should consider and discuss with your financial advisor before adding them to your portfolio. Above all is the lack of industry diversification because all REIT investments include only property investments.
Some REITs may even be less diversified when they choose to specialize in specific property developments such as medical buildings, or golf courses. Because of their focus, a REIT investment should be used as part of a diversified portfolio to provide greater diversification.
You should also be aware that REITs are subject to changes in the value of their underlying portfolios, and their prices may fluctuate with changes in their real estate holdings. REITs are also interest-rate sensitive, particularly mortgage REITs. If rates and borrowing costs rise, construction projects with marginal funding may be shelved, potentially driving down prices across the REIT industry.
-There are some unique factors to consider when selecting a REIT
Yield and Debt
High-yields are tempting, but REIT yields above certain levels may mean that there’s not enough being reinvested for acquisitions, which could affect long-term growth. Too much debt or leverage can also influence prospects for growth.
Management should have a substantial personal stake in the REIT, which should be listed in the latest proxy statement. If the REIT is new, refer to the prospectus for the management’s track record (if any) in similar enterprises.
For insight into management’s effectiveness at cutting costs and increasing rents and occupancy, refer to same-space revenue growth in the annual report’s financial analysis.
In the case of apartment REITs, for example, ask about the area’s direction of vacancy rates and rents, the amount of new apartment construction, and the affordability of home ownership. The higher the cost of home ownership, the more attractive an apartment REIT might be.
Perhaps investing in a REIT-managed fund is one way to manage risks or real estate investing, and to spare investors from investing time into researching all the avenues that should be carefully considered when investing in a diversified real estate portfolio on their own.
A real estate managed fund may invest in several different properties across different sectors of the real estate industry in several different geographic regions, giving you diversification and a way to manage your risks.
REIT Investment Checklist
Before March 2008 REITS were called Listed Property Trusts (LPT) and first emerged in the Australian sharemarket in the early 1970s.
They were viewed as low-risk and stable investments relying mainly on rents to provide reliable income. They were also considered a substitute for direct property investing as they offered easier liquidity and a chance to own part of a large range of properties and areas not easily achieved by the smaller investor.
Later some companies changed their mandate and moved into development, investing offshore and financial engineering to boost their earnings growth.
When looking for suitable REITs in which to invest, the main consideration will need to be based on your needs for income and/or capital appreciation.
A suggested checklist is provided to help you do your own research:
Don’t necessarily look at the highest returns, but consider consistent returns over long periods.
Who are the managers and do they have a good reputation, how long have they been in the business?
Types of Investment
What are the underlying risks of the types of investments that the REITs hold?
Does the REIT trade regularly and in-sufficient size for you to be able to enter and exit if and when you need to?
Franking Credits and Distributions
What is the nature of the distributions and are there any franking credits attached, how much of the distribution is tax-deferred?
How volatile is the price of the REIT, can you tolerate any volatility in the share price?
How often are valuations undertaken and how conservative are the current valuations, what are the downside risks as far as valuations are concerned?
How heavily geared is the REIT?
About A-REITs in Australia
Real Estate Investment Trusts (REITs) in Australia referred to as A-REITs, are a way to gain exposure to property investments without needing to buy and manage the physical property.
A-REITs are companies that own and manage properties on behalf of shareholders. They may own assets such as commercial buildings, shopping malls, industrial properties, warehouses, hotels and cinemas.
Like managed funds, they are pooled investments overseen by a professional manager. Also because they are listed on the ASX, you can buy and sell them through your broker, in the same way as shares.
The main reasons investors hold REITs include capital gains, dividend income, diversification, and professional management of the underlying property portfolio.
Like any investment, A-REITs have risks you need to understand. You should seek independent advice from a professional adviser before investing.
A-REITs enable you to join with other investors to gain access to large-scale commercial property assets that are likely to be out of your reach as an individual. Depending on the A-REIT you select, they can also give you exposure to a diversified property portfolio or to a specialist sector with particular income and growth characteristics.
Like shares, A-REITs can generate two kinds of return: capital growth and income, in the form of regular distributions. Because they typically earn regular rental income from medium or long-term tenants, A-REITs may also offer the potential for a consistent income stream, with distributions paid monthly or quarterly.
In some instances, those distributions may include a tax-deferred component, potentially enabling you to defer paying tax until later. But remember, tax laws can be complex and everyone’s situation is different, so it’s important to get professional advice before you invest.
By investing in A-REITs, you can select from a range of sectors and investment styles, depending on your investment outlook and your individual goals
A-REITs can offer investors a source of regular income through distributions.
Ease of access
The minimum initial investment required for an A-REIT is $500.
Investing in A-REITs can provide more diversification than if you were to own property directly as they tend to invest in multiple property assets.
The value of the units may go up in line with the share market or for reasons specific to that trust.
An A-REIT’s distributions may be reduced or not paid due to the underperformance of the underlying property.
If a substantial value of an A-REIT asset is based in one building, suburb, city or state, you may be exposed to greater risk.
Where an A-REIT uses substantial debt to fund the construction or acquisition of new property, the trust may be exposed to leverage risk.
The value of the units may go down in line with the share market or for reasons specific to that trust.
Visit Australian Stock Exchange (ASX) website for more relevant information.
REIT Apartment Investments
Real estate may provide investors with a high-yield and low-risk investment combination for greater total return potential to a diversified long-term portfolio. For most people, investing in real estate begins and ends with the purchase of a home. But some investors chose investment companies to get more advantages.
Like actively managed funds, A-REITS are generally run by specialist property managers, responsible for selecting investment properties and managing tenants, improvements, maintenance and rental.
While professional management can potentially offer significant benefits, especially in niche market sectors, it also involves additional costs, with management fees paid from the A-REIT’s earnings before distributing income.
Apartment Investments have six key characteristics that provide a unique set of investment qualities:
A steady stream of cash
Apartments receive their income from the rents paid each and every month. The income is not dependent on one sole tenant (as seen in many retail or office properties) plus the tenants still need to have housing no matter what the economic situation is.
A typical apartment investment will have excess cash (after paying operating expenses and debt service) which is typically distributed to the investors, sort of like dividends.
Benefits of leverage
Apartments are typically purchased with bank loans that equal 70%-80% of the purchase value. This means the investors only need to come up with around 20%-30% of their own cash to acquire the property.
So, assuming it is a $1,000,000 property then the investors only need $200,000-$300,000 in cash to acquire this apartment. However, the cash flow and appreciation are based on the full $1,000,000 investment. That is the power of leverage.
Earnings through pay down of the loan
As mentioned above, a big share of the money to purchase apartments comes from a bank loan. So this also means when tenants pay their rent each month they are actually making the bank loan payment for the owners.
Each month, the balance on the loan is being reduced as a result of the rents received. The equity in the property increases each month.
Earnings through rent increases
The values of apartments, just like most commercial properties, are predominately based on the amount of Net Operating Income (NOI) the property generates. So, when rents are increased this gives the investors a higher NOI which also means the value of the property has increased.
Currently, it is fairly normal to see an increase in rents, each year, of around 2%. To be fair, inflation will also affect the expenses incurred by the property so let us assume that expenses also increase by 2% each year.
However, on average expenses are about 50% of the total rents received so some basic math tells us that even if rents and expenses both increased at the same rate there will still be an overall increase in the income received each year. The value of your apartment will increase each year simply from normal rent increases.
Tax shelter through depreciation
Any time you own real estate as an investment you are able to use depreciation as an extra expense when you are filing your tax return and as a result, you will pay less taxes. Depreciation is an expense you file on your tax return even though you are not actually paying any money.
Apartments are mostly depreciated over 27.5 years so they can be used to minimize your taxes. Unfortunately, depreciation simply allows you to delay paying your taxes so when you sell the property those delayed taxes will become due but most people would always rather pay taxes at a later date than today.
Consistent and Secure Investment
When you are an investor in apartments you are actually one of the owners of the property. You can go by and touch and feel your investment. We have all seen how stocks and bonds can quickly drop in value as a result of a new skirmish in the Middle East or a cyclone or the government arguing over a balanced budget.
So many things can affect all aspects of the stock market. But, regardless of world events, your tenants will still keep paying their monthly rents simply because they need a place to live. It’s as simple as that.
Investing in apartments gives you the ability to earn double-digit returns each and every year on your money. In addition, your investing dollars give you ownership of a tangible asset that will continue to grow in value. It does not get any better than that.
If you are interested in apartment investing but are saying “How the heck do I purchase an apartment property” do not worry. There are many investment companies that specialize in finding and purchasing apartment properties and will give you the opportunity to invest with them on the purchase.
The typical process allows you to be one of the owners of a specific apartment property which gives you the security in knowing where your investment dollars went.
Some A-REITs are stapled securities, simultaneously giving investors exposure to a real estate portfolio and a funds management company or property development business.
A share in an A-REIT with this structure usually consists of one unit in the property trust and one share in the company, ‘stapled’ together, so they cannot be traded separately. The trust holds the portfolio of assets, while the related company carries out the fund’s management functions and manages any development opportunities.
Also, there are blocks of units for sale that an investor can purchase privately as an investment property instead of using a managed fund.