A REIT by any other name
Posted on December 8, 2006 - Filed Under Business |
While contemplating the direction I want to head in real estate, these side ventures into research often prove to be beneficial.
When I was describing my idea with someone, they said "Your idea sounds a lot like a REIT."
REIT’s have peppered articles in Barron’s nearly weekly since I started my subscription. But it wasn’t until I delved into these little gems that I started to understand not only their popularity but their excellent performance over time.
What is a REIT? REIT (Real Estate Investment Trust) is nothing more than a large "company" that owns real estate or mortgages or both. It consists of, at a minimum, 100 investors and no one investor controls more than 10% of the company. Many different types of REITs exist but for my field of vision, the only one I’m really concerned with is the commercial real estate REIT.
How do REITs work? One hundred investors chip in some dollar amount, let’s say $10,000 each. The REIT now has a pool of $1,000,000. With that $1 million dollars, they can purchase $4 million worth of investment real estate. Apartment complexes, office buildings, shopping centers, malls . . .
Each investor gets a percentage of the cashflow and the profits, if a property is sold.
Another investor could join at any time. They would invest $10,000 and the pool of money has just increased. This is why most REITs have assets in the billions.
Do REITs actually work? REIT’s have consistently performed over 10% per year since their inception. Even through "bubble bursts" or "market corrections" or whatever you choose to call them.
Why do REITs work? This is where the fun begins.
Let’s start off with Cliff’s First Theorem of Real Estate: People have to live somewhere.
The housing market is broken into two segments: residential and commercial. The relationship between these two is often times inverse. When one is doing well, the other is doing so-so.
If the residential market goes flat, the commercial market does well. And we’re seeing that now. You can’t walk 10 feet without stubbing your toe on an article regarding the prices of new homes falling. At this same time, rents are the highest they’ve ever been with higher rent increases in progress.
Why? Remember the First Theorem: People have to live somewhere. This leads us to Cliff’s Second Theorem of Real Estate: If people aren’t buying, they’re renting.
With that being said REIT’s minimize risk by having many, many properties underneath their umbrella. The $4 million talked about earlier could buy 20 properties (talked about here). If a tenant moves out or destroys a unit, no big deal. It won’t affect the overall picture.
Very interesting concept these REITs . . . .
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Comments
10 Responses to “A REIT by any other name”
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Well, as you know, I’m not cut out for Real Estate Investing.
Don’t worry Old Bean, the thought of asking you never crossed my mind.
If I did decide to pursue this down the road, I’d only ask investors to come to the table.
Hey Cliff,
Thanks for the article, I’ve found it quite useful.
However, do you think you have enough information to post on the legal aspects of setting up your own REIT? Investing in someone else’s is an option, but not as profitable and I’d like to have control over it myself. Surely, as in any company, the people who are doing the actual legwork would get a salary from the REIT (which would be approved by a board of directors, who would get a smaller salary due to their smaller time investment).
I’d really like to set something up in my home town between a bunch of people who I know who are young, professional, and without kids, so therefore they have somes disposable income.
Nick
Nick,
REIT’s are a bit tricky and do involve some legal wrangling. Congress has put some big restrictions on what a REIT is and what is is not.
I’m not a lawyer so handing out legal advice is not something I want to do. But I asked Lord Google and he gave me this website: http://www.investinreits.com/learn/formingareit.cfm Here, it talks more about how to setup a REIT.
Hope that helps and please let me know how your adventures go!
Clifford
Thanks Cliff,
Now I’ve got to go in search of some more information for Canada though
I’ll be posting info on my blog as I go, it might turn out that a full-blown REIT is too ambitious, but it will be fun to see where I end up with it!
NG
Cliff, “people always need to live somewhere”, but always remember, it’s all really “supply and demand”.
Case in point, the Victor Valley (Apple Valley/Victorville/Hesparia) has DOWNWARD pressure on rents on SFH because supply is overrunning demand (by a wide margin in my opinion). Yes, people have to live somewhere, but if it is already overpriced, they will move, and if there is a lot of selection, they will be able to pay less.
I think what you want is a partnership or LLC where you invest in real estate together with other investors. REITs are at the high end of the continuum of such firms. Some of our fellow bloggers such as Nirav have more experience in this area.
Pasadena, you’re absolutely correct. While my theorem may be used as a guide, it’s definitely not a law. Much like the stock market, which may go up or down 150 points per day, individual stocks may go the exact opposite.
Moom, your idea is along the lines of what I was thinking. I’ll have to check more with Nirav.
Clifford,
I believe what you’re looking for is actually a real estate syndication. It’s similar to a partnership or joint venture.
I hope I helped!
Trisha, you’re my hero of the day. It appears I have a new homework assignment.
Thanks!