New Way to Invest in Real Estate- Income Trusts and Investment Corporations

Many people are not aware of their options when it comes to investing in real estate. For a vast majority of people, the typical way to invest in real estate is by buying a piece of land or property and then either selling or renting it out to make money.

Perhaps, if someone had told me otherwise until a couple of years ago, I would have also laughed it off.

However, real estate is evolving rapidly with the changing property needs and increasing property prices. Buying/selling and renting is no longer the only way to invest in real estate and make money.

Today, there are several ways to invest in real estate, and that too without burning a hole in the pocket.

For example, there are fractional ownership models that allow people to own a fraction of a property for a specific period of time. Then there are time-share options, real estate stocks and funds, debt securities, crowdfunding platforms, and much more.

To learn more about different options to invest in real estate ownership, read: Real Estate Ownership Models: What Works for You?

Out of the many options available to investors today, two are designed specifically for investment purposes and nothing else.

• Real Estate Income/Investment Trusts (REITs), and

• Real Estate Investment Corporations (REICs)

What are REITs and REICs?

Real estate income trusts and real estate investment corporations are investment vehicles that offer individuals and institutions a way to invest in real estate without directly owning the properties.

In other words, these companies invest shareholders’ money into different real estate assets which gives them ownership but does not bind them to other obligations associated with the ownership. For example, paying property taxes and HOA charges.

Fundamentally, there are several similarities between real estate income trusts and real estate investment corporations. One can even say, they are more similar than they are apart.

Diversification of Assets

Whether investing in real estate investment trusts or corporations, it is imperative to buy shares/stocks of the fund, which are usually traded like stocks on the share market.

Both invest in a spectrum of assets and securities, including rental homes, offices and industrial spaces, infrastructure, mortgage securities, etc. However, the difference appears in why they invest in these assets.

REITs are typically publicly traded companies and are strictly regulated, whereas REICs are privately owned and are loosely regulated.

For example, REITs are required to distribute at least 90% of their taxable income as dividends among their investors in many jurisdictions, which is not the case with REICs.

As a result, investment trusts usually do not invest in non-income-producing assets and therefore offer limited portfolio diversity for shareholders.

On the other hand, investment corporations have more flexibility when choosing where they invest the shareholders’ money and how they distribute the benefits back to them.

Income Potential

Real estate income trusts and real estate investment corporations are typically the companies that invest in income-producing real estate assets. Now, the income can be rental produce, equity appreciation, or simply over-the-top maintenance profits on the property.

In most cases, the income produced is distributed amongst the shareholders, offering them a secondary income stream. However, this is not always true.

For example, income trusts usually invest in rental properties and mortgage funds or similar assets that produce regular income and therefore are preferred by investors who want to create a steady income stream from real estate.

On the other hand, investment corporations may invest in buy-and-hold properties, not necessarily producing any regular income. This means they offer capital appreciation for the shareholders in the long run instead of an income stream.

Liquidity

It is also noteworthy that both of these investment vehicles are traded like stocks. So, they are naturally much easier to liquidate whenever required, as compared to the physical properties, which can take months (or in some cases, years) before investors can cash out their equity.

However, REITs are easier to liquidate as compared to REICs, as they are traded publicly.

Market Risks and Fees

Since they are traded on the market, they are subject to market fluctuations and volatility like stocks and mutual funds. This poses a potential market risk for investors investing in real estate.

Also, since they are traded on the market, the trade usually involves a broker or a third party in the middle that handles and manages the assets. So, there are management fees and other expenses involved which can reduce returns for the investors.

Where do these Companies Invest in Real Estate?

The general rule for real estate income trusts and investment corporations is to invest in real estate-related assets, as we have already established.

However, for a young investor starting out to invest in real estate trusts and corporations, this information is like a half-baked cake, which is difficult to swallow.

In addition to this, following up with the market trends, analysing the data, and understanding the market emotions are all too technical for many investors.

Of course, they are necessary but they are also tough nuts to crack, especially for the retail and micro investors.

It is always better to consult with a market expert to learn from their experience before getting involved in the technicalities of the investment market.

However, there’s one thing that every investor can do before setting foot in the investment game- understand the types of investment assets that real estate trusts and corporations deal in.

Equity in Real Estate

For homeowners and investors, equity in real estate is simply the difference between the appraised market value of the property and the outstanding mortgage balance.

However, since there is no mortgage involved in REITs and REICs, the equity is the appraised value of the property distributed among the shareholders relative to their share in the property.

Typically equity assets do not produce any direct steady income but offer equity in ownership and/or capital appreciation which can be cashed out by selling the asset.

Investing in real estate income trusts and investment corporations that deal in equity can provide several financial benefits like increased borrowing power and reduced interest rates. Plus, there’s wealth generation in equity holdings as well.

Debt or Mortgage-Backed Securities

Another interesting real estate investment instrument is debt or mortgage-backed securities.

How it usually works is that the capital from several investors is pooled and then invested in either the funds backing mortgage institutes or directly invested with the mortgage lenders.

Now, REITs and REICs take it a step further and invest in funds of funds, or in other investors usually backed by a pool of mortgage funds, which are further backed by collaterals aka mortgaged real estate or some other type of real estate debt.

The idea behind investing in such instruments is to seek a regular stream of income.

Here’s an oversimplification of how debt or mortgage-backed securities generate regular income - the shareholders’ money is pooled and invested in debt or mortgage-backed securities which further lend the money to retail and institutional mortgage lenders. The interest earned on retail debt trickles back to the securities and from there to the individual investors or shareholders. Thus, creating a steady stream of income for shareholders and investors.

Hybrid Investments

The most popular type of investment strategy or instrument used by real estate investment trusts and real estate investment corporations is the Hybrid Fund. As the name suggests, these funds are a mix of both- equity and debt.

As the wise always say, never put all your eggs in one basket, REITs and REICs follow it and prefer investing the funds in a multi-asset allocation format.

Now, the percentage of these holdings may vary, but the net result is always a mix of income and capital appreciation for the investors and shareholders.

Hybrid investments are usually preferred by investors who wish for regular income and equity appreciation, without taking too much risk.

Perhaps, this is the reason, why hybrid real estate investments are considered to be the safest horse to bet on.

In addition to these general categories, there are also a number of specialized REITs and REICs that invest in specific types of real estate, such as healthcare facilities, student housing, hospitality, or infrastructure. If you are interested in learning more about these specific investment options, we recommend consulting with a seasoned investment advisor.

How to Invest in Real Estate Instruments- REITs and REICs?

Investing in real estate, especially physical real estate has always been tedious, requiring a lot of paperwork and legal formalities to be fulfilled by the investor. On top of this, there are maintenance expenses and taxes associated with the asset.

On the other hand, investing in the stock market is considered relatively easier.

Since REITs and REICs are also traded like stocks, they bring the best of both worlds to the table for retail and micro investors.

However, it would be wrong to assume that there are no regulatory formalities required before investing in real estate funds.

Although the specific requirements may vary depending upon the jurisdiction in which real estate income trusts and investment corporations are located, there are some common requirements to be fulfilled by all investors all around the world.

Know-Your-Customer (KYC) and Anti-Money Laundering (AML) Checks

Investors are typically required to provide documentation to verify their identity and address in order to be able to invest in real estate trusts and real estate corporations.

Additionally, many jurisdictions also require the investors to produce proof of funds along with the source. This is to ensure that the funds invested in real estate trusts and corporations are in no way associated with money laundering.

These are pretty basic checks and can be done digitally from any computer sitting anywhere in the world.

Suitability Assessment

Investors may be required to complete a suitability assessment. This is to ensure that the investors understand the risks involved in investing in real estate income trusts and real estate investment corporations.

Typically this assessment is done while setting up the investor’s account, physically or digitally.

Tax Compliance

Depending upon the types of funds and asset holdings of the real estate income trusts and real estate investment corporations, investors may need to pay taxes on their capital gains.

The taxes to be paid would depend upon the local tax laws and regulations, in addition to the central or federal laws.

In addition to these, there are certain legal and regulatory considerations that investors should check before investing in REITs and REICs.

Investment Limits

Depending upon the jurisdiction, there may be limits on the amount of money that investors can invest in real estate income trusts and real estate investment corporations.

The limits may also vary depending on the location of REITs and REICs, investor class, and investor’s location.

Foreign Investment Restrictions

In some countries, foreign investors may not be allowed to invest in REITs and REICs openly.

Depending on the jurisdiction and the type of investor, there may be restrictions on currency, taxes, investment limits, and so on.

Conflicts of Interest

REITs and REICs may have conflicting interests with their investors.

Conflict of interest arises when the professional judgment or actions of an individual or entity are compromised for their personal benefit.

It is important to be aware of these potential conflicts as an investor and take steps to mitigate them.

Transparency and Disclosure

REITs and REICs are also required to disclose certain information to their investors. This information may include financial statements, investment strategies, and risk factors.

It is important to go through these disclosures to understand the potential threats for an investor, be it in terms of losses, conflict of interest, or investment limits.

In the end, it is important to carefully review all investment-related documents before investing in real estate income trusts and real estate investment corporations.