An Explanation of Real Estate Investment Trusts (REITs)
Real-estate securities come in many forms and individual investors can take several different approaches to investing in real estate without actually buying and selling the properties.
REITs offer several benefits over actually owning properties. First, they are highly liquid. In other words, while it's difficult and time-consuming to buy, rent and sell houses on your own, this isn't the case with REITs, which can be bought and sold as easily as stocks. Second, REITs enable you to own a share in non-residential properties as well, such as hotels, malls, and other commercial or industrial properties. Third, there's no minimum investment with REITs: you can start as small as you want; this isn't the case with actually buying a house.
REITs do not necessarily increase and decrease in value along with the broader market. However, because they also pay yields in the form of dividends no matter how the shares perform, they are considered fairly safe investments. REITs can be valued based upon fundamental measures, similar to the valuation of stocks, but different numbers tend to be important. Funds From Operations (FFO) tends to be a good metric because it eliminates many of the complications that cloud the indications presented by net income or more traditional measures of performance. FFO is calculated by taking net income and removing the effects of debt restructuring, one-time charges, property sales, depreciation and amortization. The holdings and transactions of REITs should also be studied to determine diversification and aggressiveness, as REITs can have a wide variety of investment styles and objectives.
Equity REITs draw earnings from rent on properties that they own as well as capital gains from selling those properties. Mortgage REITs take a different approach by lending money to developers instead of amassing a group of properties. Earnings, therefore, are derived from interest. Hybrid REITs invest in both property and mortgages and draw earnings from rent, capital gains and interest.
If you ever wanted to invest in real estate but didn't want to go through the hassle of finding the right house, buying it, renting it out, and later selling it, you might want to consider including REITs in your portfolio.