Owning property is a path to wealth and success many people choose. There is however one minor issue with getting onto this path. That’s the extremely high levels of investment required to enter the market. That is where buying into a REIT becomes an option.
I will review what REITs are below. I will also give my view on the key benefits and risks these companies have.
what is a reit
REIT – Real Estate Investment Trust. These are types of companies that operate a portfolio of properties that generates income. This is mostly rented income.
REITs operate by the means of getting a number of investors to contribute. This pot of money then gets invested. As the company grows and expands – more investors can join through buying the existing shares of the company.
The types of properties REITs can invest have no limit. The only condition – these have to bring income. Most frequently these are residential or commercial properties like a shop or a shopping centre.
There are other types of REITs available as well – some that are actually more niche that others. You can buy into REITs that operate only in medical sectors. Some choose to only buy storage facilities.
I can assure anyone – there is a REIT that operates the type of property you have been dreaming to own for as long as you remember yourself.
benefits of buying into a reit
There is a list of benefits that the investor gets with a REIT. Before buying a company that operates in a property sector make sure you understand if this is a REIT or a standard company that manages properties.
First of all – standard companies that operate within property get taxed. Once the tax is paid and the dividends are distributed amongst the investors – investors also get taxed. You avoid this with REITs. One of the biggest benefits for REITs – there is no need to pay any corporate tax.
Next, REITs are required to distribute at least 90% of their profits between the shareholders. This makes the yields these businesses pay very tempting for many. This isn’t the case for a standard company either.
On top of that – you get diversification. REITs the same as standard companies will normally operate a large number of properties. If one of these doesn’t get rented out for a period of time – the rest will be able to cover the bill.
As these are traded on a share basis – you can easily enter the market. Some of the REITs trade at below £1 per share price point. You can now make a decision – grab yourself a take away coffee or get 3 shares in a REIT.
how to use REITS in your portfolio
I often see REITs being a tool in portfolios that focus on dividend income. As REITs are required to distribute 90% of their profits – you often get some healthy dividends with these.
In the current environment with many stock prices being suppressed – you often find dividend yields north of 5%. That’s not a bad income to get. This most often will beat the interest rates your bank will offer you on your savings.
On top of the above – first £1,000 of dividend payments is tax free. This used to be £2,000 however got reduced at a recent budget.
A further hack you can use – buy these shares though an ISA account. This way – you will be owning a business that is not required to pay any tax through a tax free investment account. This can be called a perfect tax evasion scheme.
On top of the attractive dividends you get – there is a possibility to get a benefit as a result of property value appreciation over a period of time. This could get reflected in the increased share price over time.
the risks reits have
One of the major risks many REITs have – they are heavily leveraged businesses. They borrow money in order to grow their portfolio.
The above makes sense in order to expand business. The risk however is at times when interest rates are rising. This can result in a large proportion of the profits being eaten up by the debt.
There are two consequences to this. Firstly, your dividend gets reduced. Potentially these can be cancelled altogether if there is no profit to distribute. Secondly, the first issue can result in the share price to drop at the same time. You can be hit by both sides of this.
A further thing to keep in mind – the businesses are required to distribute 90% of their profits. This results in their cash holding being very low. At times of uncertainty and rentals dropping (like COVID times) – share holders can get diluted by new shares being released to make sure the business stays afloat.
summary
In my personal view – REITs can be an interesting way for you to get exposure to the property segment. You can get nice dividends without the need and headache of managing the property yourself.
If you think – some of these REITs are currently offering 6-7% annual return. Not many rental properties people buy offer the same return after all the expenses and taxes are taken into the equation.
You are also the one taking all the risks with buying a property yourself. If the tenant in your property does not pay rent – 100% of your income is gone. You might potentially have to pay mortgage on that property as well.
With a REIT – diversification helps you mitigate some of those risks. The properties are also looked after by people who know exactly what they do.
If you are interested in exploring REITs in more detail – the list of UK REITs available in FTSE350 can be found here.