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Differences of the 4 Types of Real Estate Investments - Part II

5/21/2015

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In our previous blog post, we discussed the 2 real estate investments that happen outside of the public exchanges.  Now we will focus on the Public Equity part of the RE investment - investing in REITs.

What is a REIT?
REIT stands for real estate investment trust, it is a company that owns and operates income-producing real estate, and sells shares to the public.  By investing in a REIT, you become a real estate owner, that is why we call investing in REITs a type of Public Equity participation of the real estate investment.

What Makes REITs special?
There are two features that are special to REITs:
1. A REIT's main business is to manage a portfolio of properties, in other words, rental properties are its product.
2. A REIT must distribute most of its earnings to shareholders in the form of dividends, in this way, a REIT can enjoy favored tax status as a business entity.

How to Analyze REITs?
REITs could be analyzed from 2 angles -

Buying a REIT is similar to buying a renal property, your analysis should focus on the REIT's income growth potential, occupancy rates, leverage ratio, etc.

Buying a REIT is also similar to buying high-yield bonds and dividend-paying stocks, so you want to look at some of its financial metrics.  Unfortunately, Net Income is not a good measure for REITs because of something unique to real estate - depreciation.  A depreciation is treated as an expense, which reduces the Net Income.  However, depreciation does not impact cash flow, therefore the cash flow from operation is a better measure of the business as it removes the distortion of depreciation.

Net Asset Value is another metric worth noting - NAV is calculated by dividing operating income by cap rate of the property, then subtract mortgage debt.  The NAV is a better measure than book value of a REIT, as it reflects the changing market situations and the impacts on the value of the properties.  Unfortunately, it requires lots of due diligence to get fairly accurate analysis of a REIT's NAV.

The Bottom Line
Like investing in individual stocks that carrier higher risks and potentially earns you higher returns, so does investing in REITs.  Also, in order to be successful in investing in REITs, it takes lots of homework, just like if you want to succeed in investing in individual stocks.

In our next blog post, we will discuss the Public Debt part of real estate investment.



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