What are REITs and how do they function?

For centuries, real estate investments have been a popular form of investment. For many years, smartcrowd.ae was equated with having a large sum of money to invest. However, in recent years, options like Crowdfunding and REITs have provided opportunities for small investors to invest in real estate without spending a fortune. In this article, we will talk about Real Estate Investment Trusts (REITs) and also look at the way they function.

What are REITs?

For the sake of understanding the concept, a REIT can be considered similar to an Exchange Traded Fund (ETF) or a Mutual Fund. The difference is that, instead of holding a collection of stocks, a REIT holds a portfolio of residential and/or commercial properties or mortgages. As an investor, you can purchase units of a REIT depending on your financial plan and benefit from the growth of the real estate sector.

Since their launch, REITs have gained popularity with investors as they offer an opportunity for a long-term growth, which is reflective of the real estate market. Also, REITs are known to offer good dividends which make them a formidable investment alternative. However, like any other investment option, REITs have their own set of advantages and disadvantages. Therefore, it is important to understand them well before investing.

How do REITs function?

To understand the way how REITs function, it is important to understand the different types of REITs available in the market.

In terms of tradability, REITs are divided into three classes – Public, Private, and Non-Traded.

  • Public REITs – These are listed on major stock exchanges. Investors can buy/sell units of the REIT whenever they want.
  • Private REITs – Sometimes the trust can specify investors who can invest in the REIT and/or set a high minimum investment amount to restrict the REIT to a limited set of people. These are not traded on the stock exchange and are available through the trust only to specific investors.
  • Non-Traded REITs – These are not listed on any stock exchange and must be bought/sold from the company that operates the trust.

Also Read: How is Real Estate Crowdfunding different from REITs?

Usually, investors prefer public REITs as it offers liquidity and they can sell their units immediately if the market does not perform as expected. On the other hand, in the case of non-traded REITs, selling the investment can be a time-consuming process.

Apart from the tradability factor, the composition and quality of holdings are also important for a successful REIT. Based on their composition, REITs can be of three types: Equity, Mortgage, and Hybrid.

Equity REITs – These REITs own or manage income-generating properties like apartment buildings, offices, warehouses, shopping centers, etc. and generate their income from the rent received. These trusts deduct all expenses incurred for managing the properties and calculate their income. A large part of this income is distributed among shareholders as dividends. Sometimes, income is also generated by selling properties.

As an investor, when you are purchasing an Equity REIT, you must take all precautions that you take while purchasing the stock of a company. Equity REITs, usually, have a specialization like:

  • Residential – acquiring residential properties
  • Office – acquiring commercial centres, office buildings, etc.
  • Retail – acquiring shops, malls, etc.
  • Health-care – acquiring clinics, hospitals, path-labs, etc.
  • Industrial – acquiring factories, industrial structures, etc.

Mortgage REITs – These REITs either buy existing mortgages or mortgage-backed securities (MBS) or lend funds to property owners. Their main source of income is the interest received on these investments. These REITs also have a market-focus like Equity REITs.

Also Read: Dubai’s New Mortgage Law

Hybrid REITs – These REITs are simply a mix of Equity and Mortgage REITs. They offer the benefits of both.

Benefits of Investing in REITs

REITs offer the following benefits to investors:

  • Income & Growth – Investing in REITs offers competitive rates of return over the long-term. These returns match those obtained from investing in stocks and/or bonds.
  • Liquidity – As discussed earlier, if you invest in publicly traded REITs, then you can easily convert your investments into cash. This is because they are traded on the major stock exchanges.
  • High Dividend Yield – Since most REITs distribute a large portion of their income among shareholders as dividends, the yield is higher than other equity investments. Also, REITs ensure a flow of income in varying market conditions.
  • Diversification – Adding real estate to your portfolio of investments can increase its diversification. It is believed that real estate has a low correlation to other asset classes. Therefore, it is a great way to diversify your portfolio.
  • Hedge against Inflation– When inflation rates increase, the prices of goods and/or service increase too. Also, most investments tend to offer lower returns when the market prices are high. However, real estate prices and rents increase with an increase in inflation. This allows REITs to generate a steady source of income even during inflation.

While there are many benefits of investing in REITs, you must ensure that you consider the tax implications, fees, and charges, and opt for a well-diversified portfolio of the REIT.

In the UAE, everyone who is eligible to invest – individuals, funds, and institutional investors – can invest in REITs. There are currently two main Sharia-compliant REITs in Dubai:

  • Emirates REIT – launched in 2010, managed by Equitativa, and is publicly traded on NASDAQ-Dubai.
  • ENBD REIT – launched in 2017 by Emirates NBD Asset Management and is publicly traded on NASDAQ-Dubai.

REITs offer a simple alternative to obtain income from the real estate market. However, it is important that you are clear about your financial goals, risk preference, and time horizon of investment before buying a REIT. In the UAE, REITs are still in their early stages. However, with Dubai emerging as a truly global city and investors turning to Dubai for investment opportunities, the REIT market will soon show exponential growth.

Image Credit: Edubirdie https://edubirdie.com/.

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