- March 19, 2018
- Posted by: Treadstone Law
- Category: Uncategorized
By Yousef Rassas
In 1960, President D. Eisenhower signed legislation that merged real estate and stock based investment by creating a Federal Real Estate Investment Trust (REIT). This new ‘alternative investment’ allowed investors to earn income by pooling their resources to fund a portfolio of income producing real estate projects through purchasing company stock or a mutual fund. Today, investing through an REIT remains one of the best ways of diversifying your portfolio away from the three major asset classes of bonds, cash or equity.
What exactly is a REIT? REITs are restricted to investing in mortgages and various classes of property; such as, commercial, lodging, residential or industrial properties. Investors are capable of choosing between REITs that purchase form a single asset class or multiple classes. This diversification advantage allows shareholders to hedge against risks associated with investing in real estate as portfolios carry a diverse tenant mix, geographies and project scale. REITs are required to distribute at least 90% of their income to shareholders in the form of dividends at the end of every fiscal year; in turn, creating a tax benefit for investors. Investors are able to exploit synergy created from focusing on a single industry.
One of the main advantages of investing in a REIT is access to a team of experts that are skilled at growing your initial investment. For example, by leveraging a large portfolio, they are more capable of negotiating better terms prior to acquiring a real estate asset. Due to these factors, REITs recorded higher returns than both corporate bonds and the S&P 500 over the past 25 years.
What is a Private REIT?
The most significant difference of a Private REIT, known as an Exempt Market Product (EMPs), is that it is not listed on a stock exchange. In turn, public REITs tend to be highly affected with the movement of stock prices, reducing some of the synergies gained from diversifying the portfolio. During the financial crisis of 2008, public REIT prices saw a decline in prices by 34%; on the other hand, private REITs witnessed a positive 3.7% return. Private REITs are much less volatile than its public counterpart as the price is based on the actual appraised value of the underlying real estate assets that exist in the company’s portfolio.
Many investors shy away from investing in Private REITs due to their lack of transparency relative to Public REITs. The availability of detailed financial reports allows investors to analyze the cost of the management team, corporate-level and project-level cash flows or performance data. However, a well-established Private REIT firm with a strong track record of performance understands the importance of educating and informing its investors.
The Ideal Private REIT:
- Experienced Management team that holds a proven track record and strong reputation. Real estate investing is an actively managed business, which means you are really investing in the management team in charge of maximizing the return on equity of its portfolio. Therefore, the management team is your greatest investment risk, look for a company that is very transparent with their investments and strategies.
- Diversified Portfolio. Look for a company that takes calculated investments that significantly limit your financial risk whilst minimally decreasing your return on investment. For example, a company that only invests in office spaces at a specific geographic region will be severally affected by fluctuations in the vacancy rate.
- Management fees should be justified by an increase in investment value. Look out for exorbitant fees that look to increase the wealth of managers at the private equity fund at the expense of investors. Also, management fees should be clearly defined and disclosed leaving no room for hidden fees that may result in investors going from a capital gain to a loss.
- Ensure that the redemption fee put in place is fair- Real estate investments require you to be locked in for a period anywhere from 2 to 15 years. A redemption fee is designed to discourage short-term or premature trading.
- Access to audited financial reports. Private REITs are not required by law to make audited financial reports accessible to their shareholders. However, it is important to look for a company that is willing to share their annual reports, offering memorandum, prospectus and financial statements for both prospective and existing investors.
- Earnings- The two main accounts an investor should assess prior to investing capital in a private REIT are earnings from operations and cash available for distribution (CAD). Regular income figures will include a depreciation account causing them to look more favorable. By considering these accounts, you can begin to develop a picture on the company’s ability to generate cash for its investors.
Capozza, D. and Seguin, P. (1999). Focus, Transparency and Value: The REIT Evidence. Real Estate Economics, 27(4), pp.587-619.
Ling, D. C. and Naranjo, A. (2015), Returns and Information Transmission Dynamics in Public and Private Real Estate Markets. Real Estate Economics, 43: 163–208. doi:10.1111/1540-6229.12069
Marshall, J. (2016). Commercial Real Estate: History & Community – The Commercial Real Estate Daily – Medium.
Pagliari, J. L., Scherer, K. A. and Monopoli, R. T. (2005), Public Versus Private Real Estate Equities: A More Refined, Long-Term Comparison. Real Estate Economics, 33: 147–187. doi:10.1111/j.1080-8620.2005.00115.x
2008 ICREIM/IPD Canada Annual Property Index
About the Author:
Yousef Rassas is an Associate at Treadstone Law. Yousef Rassas is currently a fourth year Bachelor of Business Administration student at the University of Toronto. He is currently pursuing a Management specialization. An appetite for opportunity has left Yousef’s past filled with unique experiences. From becoming an entrepreneur managing small to large hardscape renovations to grabbing the attention of large multinational corporations such as Mölnlycke and Netflix through creative marketing campaigns for a production company – Yousef is a brilliant mind with a unique background. In his spare time, Yousef works alongside student unions at various universities to execute cost efficient fundraising events for various initiatives.