Everything You Need to Know About Real Estate Investment Trusts (REITS)

Real estate investment trusts (REITs) are a unique type of investment vehicle that allows investors to benefit from the power of real estate without having to purchase an entire property. They are often touted as an alternative to the stock market. But what exactly is a REIT, and how does it work?

Many people think that owning shares of a REIT is similar to buying a piece of property directly, but it’s not quite that simple. With a REIT, you get exposure to several different types of real estate without having the headaches associated with direct ownership, such as finding tenants, collecting rent, and making repairs on an ongoing basis.

In this post, we look at everything you should know about REITS and how they can help you diversify your portfolio.

Real estate investment trust
Sample composition of a Real estate investment trust

What are REITs?

A real estate investment trust is a company that owns, operates, or finances income-producing real estate properties. The company usually issues shares to investors and pays them regular dividends based on its profits from renting out those properties.

REITs invest in commercial properties, such as office buildings, apartment complexes, hotels, and shopping centers. They also invest in mortgages on these properties, which they use to raise money from investors to buy more properties.

When an investor buys shares in this type of company, they become owners of the trust’s assets and profit from them through dividends paid by the company.

Types of REITs

There are two types of REITs: equity REITs and mortgage REITs. Equity REITs own properties outright, while mortgage REITs use debt financing to increase their purchasing power. REITs are further divided into

  • Development Real Estate Investment Trusts (D-REITs)

A D-REIT is a type of REIT in which the investor pools their resources to acquire real estate to develop and construct projects and associated activities.

  • Income Real Estate Investment Trust

An I-Reit is a type of REIT in which investors pool their resources to acquire long-term income-generating real estate. These include housing, commercial, and others.

  • Islamic Real Estate Investment Trust.

The Islamic REIT undertakes shariah-compliant investment activities.

REITs are further classified into the following categories:

Publicly traded REITs

These are REITs listed on the National Securities Exchange. In Kenya, they are traded on the Nairobi Stock Exchange.

Public nontraded REITs

These are regulated by the stock exchange, but they are not traded publicly.

Private REIT’s

They are not traded on or regulated by the stock exchange. Private REITs are mostly sold to institutional investors.

REITs are regulated by the Capital Market Authority in Kenya, and they are required to distribute their after-tax profit to the unit holders as a dividend.

How to Invest in Real Estate Investment Trusts

 You can invest in REITs by buying the shares of the REIT companies listed on the Nairobi Stock Exchange. Alternatively, you can invest via exchange-traded funds that invest in baskets of REITs.

Before you invest in a REIT, make sure you do your research and choose the best. Here is what you should consider.

Management

The profitability and asset appreciation is determined by the management’s ability to pick the right investment and manage it. Before buying a REIT, you need to consider the track record of the management and their team.

Pick a REIT with a management team that has an excellent track record. Check how the team is compensated, whether it’s based on performance. If the compensation is based on performance, chances are they will do better.

Portfolio Diversification

It’s important to buy a REIT that is properly diversified. Real estate market returns fluctuate based on the type of property and the location. Make sure the REIT you want to purchase is diversified properly. If a REIT is reliant on one type of property and there is a drop in income, it means you will not earn a substantial income.

A well-diversified REIT will also have access to capital to fund future expansion.

Earnings

Check the REITs’ funds from operations and the cash left to distribute to investors. These are important metrics that indicate the performance of the REIT and the amount of income you are likely to receive.

It’s important to understand the difference between income and funds from operations.

Credit rating

A REIT’s credit rating indicates its financial stability. Look for REITs with a higher credit rating.

Payout ratio

Although the regulated payout ratio is at least 80% of the after-tax profit income, look out for REITs that offer a higher payout ratio.

Economic sensitivity and the cycle of business occupying the real estate

It’s important to understand the kind of businesses that occupy the property. For instance, REITs for hostels will have a low income during holidays or pandemics. Other businesses that occupy the REIT depend on the strength of the economy.

Health-care-related industries, for example, are more recession-resistant than hotels.

It’s also important to assess the lease of the businesses occupying the REITs. This determines the returns you, as the investor, can expect. Long-term leases lock in the tenants and minimize vacancies during tough times.

Advantages of Investing in REITs

The advantages of investing in REITs include:

Diversification

 Real estate is considered a stable investment because it’s not subject to swings in the economy or market conditions like stocks. Owning a REIT gives you exposure to the real estate market without having to be a landlord yourself.

Tax benefits

REITs enjoy various tax benefits, making them attractive to investors. They are exempt from income, stamp duty, VAT, and capital gains in some cases. However, it’s important to note that you will pay tax on dividends or interest income.

Consistent income

REITs are required to distribute at least 80% of their after-tax profit to the shareholder. This can provide a stable and consistent form of income for the investors.

Liquidity

REITs are more liquid as compared to properties. You can easily buy and sell units on the stock exchange.

Long term returns

REITs offer investors competitive long-term returns.

Disadvantages of REITs

Tax on dividend

It’s important to note that dividends received from REITs are subject to tax. In Kenya, any dividend paid to a resident is subject to a 5% tax. Dividends paid to corporations are subject to a 12.5 percent withholding tax, while dividends paid to nonresident individuals are subject to a 10% withholding tax.

Interest rates

REITs can be bought through debt. Such rates will be impacted in times when interest rates go up. The prices of REITs bought with debt will be affected when interest rates go up.

Real estate trends may affect the value of

REITs.

REITs, like any other real estate property, are subject to volatility. Trends in the marketplace or pandemic-like issues will affect the value of REITs. For example, the pandemic resulted in people working from home. The aftermath of the pandemic is that more companies don’t see the need to lease offices.

Little or no influence on performance

Investors have little or no influence on the performance of REITs. You do not influence the REIT’s performance.

The potential of paying high fees

Before you invest in REITs, consider the tax on dividends, interest rates, and property values. It’s important to factor in the management fees and transaction fees before you choose to invest in REITs. Look at the fine print to avoid REITs that charge high fees, resulting in lower dividends.

They work best as a long-term investment.

REITs work best as a long-term investment. Other than the fluctuations in interest, other factors affect the prices of REITs in the short term. Don’t put the money you will need urgently in REITs.

Are REITs risky investments?

REITs are not as risky as stocks and bonds, but they do carry some risks.

The riskiest part is if you buy a REIT from a company that is considered to be “leveraged” or “highly leveraged.” This means that they are borrowing money to invest in real estate, which can increase your risk if it goes wrong (which is why most REITs do not take this approach).

Other than that, there is also the risk of performance, especially if there is no diversification. If REITs invest in office buildings, as an investor, you need to consider the risks involved.

REITs in Kenya

In Kenya, REITs are regulated by the Capital Markets (Real Estate Investment Trusts) (Collective Investment Schemes) Regulations, 2013. According to the Capital Markets Act, Chapter 485A, REITs must follow the below requirements.

  • Prepare reports as per the International Financial Reporting Standards (IFRS).
  • Use the accounting standard IAS 34: Interim Reporting 

In addition to the above, they also must follow the Capital Markets (Real Estate Investment Trusts) (Collective Investment Schemes) Regulations, 2013, which state the below:

  • Distribute at least 80% of the income from REITs to unitholders.
  • They must also invest 75% of an I-REIT portfolio in income-producing real estate within two years of being authorized.

Reits in Kenya

IssuerNameType of ReitListing date 
ILAMFahariI-REITOctober 2015 
Acorn Holdings LimitedAcorn ASAI-REITFebruary 2021 
Acorn Holdings LimitedAcorn ASAD-REITFebruary 2021 

In a nutshell? Research is key. You can’t just pick a REIT on a whim. You need to be sure that it’s the right fit for you and your portfolio, according to your risk tolerance and investment strategies. If you go into the investing process armed with the information you will be equipped to make the best decision. As with every investment you make, be sure you’re doing so in a way that aligns with your long-term goals and objectives.

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