Dear Mr. Gisriel:
I'm thinking about investing in real estate. A friend told me that I should check out REITs. What is a REIT? Are there different kinds? How do I invest in a REIT?
Dear Mr. Roland:
A real estate investment trust (REIT) is a publicly traded company that manages a portfolio of real estate to earn profits for its stockholders. A REIT is an investment conduit, created by an act of Congress in 1960, designed to provide investors with a tradable interest, i.e.: a security, in a pool of real estate-related assets.
REITs are required by law to distribute 95 percent of all net taxable income to investors in the form of dividends. Thus, they are "pass-through" investments with light dividend yield relative to other stocks.
All REITs are required to derive at least 75 percent of their gross income from real estate investments, either rental income from owning property directly, or interest income from holding mortgages on property. Shares of REITs are freely tradable. There are REITs listed on all major stock exchanges.
"Equity" REITs invest in diverse properties such as shopping centers, retail facilities, office building, apartment complexes, industrial warehouses and hotels. These "equity" REITs own and manage these income-producing properties and receive rents.
"Mortgage" REITs specialize in lending money to building developers through mortgages and then receive loan payments. These "mortgage" REITs then pass the interest income to shareholders. There are also "hybrid" REITs that both invest in mortgages and own and manage commercial properties directly.
"Funds from operations" (FFO) is the most important measure of performance and potential growth for an equity REIT. FFO is defined as net income (i.e.: debt pay-down) plus depreciation and amortization minus any gains or losses from property sales or extraordinary items.
Generally accepted accounting principles (GAAP) require that companies, including REITs, depreciate the assets that they hold over some specified holding period or estimated life of the project, usually 30 years.
This depreciation charge is not an actual cash expense but is included on the annual statement as an expense against operating income. For example, a strip shopping center valued at $900,000 with a 30-year depreciation would show a yearly depreciation charge or expense of $30,000 per year.
The result is that net income is less than actual cash flow. Thus, equity REITs can consistently pay out more dividends to shareholders than net earnings might indicate. Currently, many equity REITs pay out yields of 6 percent to 10 percent yearly or more.
Because of these high yields currently available from REITs and because of the generally high level of most stock bracket indexes, many investment advisers are now recommending shares of REITs to their clients for 1997.
Michael Gisriel is senior vice president of Fountainhead Title Group of Columbia and host of the weekly radio show "All About Real Estate" on WCBM from noon to 1 p.m. on Sundays.
Send real estate questions to Michael Gisriel, c/o Mailbag, Real Estate Section, 501 N. Calvert St., Baltimore 21278.
You can also leave questions on Sundial, The Baltimore Sun's telephone information service, by calling (410) 783-1800 and entering the code 6170.
Pub Date: 12/22/96