Have you ever wanted to learn how to invest in commercial real estate, but are hesitant to leave the single-family home market for fear of biting off more than you can chew? Don’t worry, you are not alone. Learning how to invest in commercial real estate takes a lot of commitment and a different skill-set than you are probably accustomed to. However, there is a way to take advantage of the currently hot commercial real estate market without acquiring the properties yourself: buy shares of a commercial REIT (real estate investment trust).
Real estate investment trusts, otherwise referred to as REITs, are individual companies that own or finance income-producing properties, not excluding commercial real estate. According to REIT.com, these particular investment vehicles are modeled after mutual funds, and “provide investors of all types regular income streams, diversification and long-term capital appreciation.”
Not unlike the assets on Wall Street, commercial real estate investors invest in portfolios of large-scale properties with the help of REITs. There isn’t a better way, at least that I am aware of, to capitalize on a strong commercial real estate market without personally investing in properties yourself. What’s more, an REIT portfolio may offer investors the perfect opportunity to learn how to invest in commercial real estate.
“In the same way shareholders benefit by owning stocks in other corporations, the stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy or finance property,” says REIT.com. In other words, it is entirely possible to invest in commercial real estate without the added responsibility of becoming a landlord or even marketing for properties.
Making the jump from single-family homes to learning how to invest in commercial real estate can be an incredibly lucrative career choice. However, commercial real estate investing is a different animal; the numbers on a single deal alone can trump even the most expensive single-family homes. Investing in commercial real estate will require a new set of skills, and some people will want to make the transition a little slower. That said, REITs might be the perfect vehicle to introduce investors to the world of commercial real estate investing.
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It is important to note, however, that REITs are not your average stock, nor do they represent a hands-on real estate investment; they essentially reside in their own niche. While often mistaken for the broader equity market, a commercial REIT is its own distinct asset. To qualify as an REIT, a company must first meet the following criteria:
At least 75 percent of an REIT’s assets must be in real estate.
At least 75 percent of an REIT’s gross income must be derived from rents from real property, or from sales of real estate.
REITs must distribute at least 90 percent of their taxable income to shareholders in the form of dividends each year.
REITs must take the legal identity of a taxable corporation.
All REITs must be managed by a board of directors or trustees.
REITs must have at least 100 shareholders.
An REIT can have no more than 50 percent of its shares held by five or fewer individuals.
Real estate investment trusts are essentially companies which invest in real estate. Consequently, investors may invest in REITs to indirectly invest in real estate. It is worth noting however, that the real estate in which an REIT invests may vary. As a result, commercial REITs allow investors to diversify within their own REIT portfolio. A commercial REIT may specialize in any number of industries, not the least of which include:
Retail REITs: As their name suggests, retail REITs specialize in owning retail property. Specifically, retail REITs are known for owning malls all across the country. However, retail REITs simply own the real estate businesses rent for their daily operations. As a result, retail REITs typically generate rent from businesses; all of which pay to open up shop in malls or similar environments.
Residential REITs: Residential REITs own and operate multi-family properties. More specifically, residential REITs own the buildings people live in, like apartment complexes and condos. Residential REITs may also own different variations of manufactured housing. Either way, these types of commercial REITs generate csh flow from collecting rent from residential tenants.
Healthcare REITs Healthcare REITs own the land and buildings used by hospitals, medical centers, nursing facilities, and retirement homes. While they may not generate csh flow from the patients themselves, they do collect rent from the individual healthcare business renting their properties.
Office REITs: Office REITs invest in office buildings. That means office REITs will collect rent from business who choose to rent in their office buildings.
Mortgage REITs: Unique to the others on this list, mortgage REITs don’t actually invest in physical real estate. Instead, mortgage REITs will pass on equity investment to invest in the secondary mortgage market.
I would be remiss if I didn’t at least acknowledge that there isn’t a specific road you need to follow in order to learn how to invest in commercial real estate REITs. For what it’s worth, REITs are renowned for their diversity, and the method you choose to invest in them is no different. Of particular importance, however, is the manner in which you select the REITs you intend to invest in. If for nothing else, deciding on which REIT to invest in isn’t like picking a stock.
REITs are not valued in the same way typical stocks are; they are less reliant on earnings per share and net income figures. Whereas stock options account for depreciation in evaluating their net income, commercial REITs are a bit different. For what it’s worth, REITs do account for depreciation, but with a caveat: real estate tends to appreciate year over year. The assets or properties held by REITs are typically subjected to the same laws of depreciation, but in reality the assets held by REITs appreciate more often than they depreciate.
Instead of net income, it is wiser to evaluate an REIT based on its funds from operations (FFO). FFOs identify the volume of cash flow directly resulting from operations, and much more accurate for assessing the viability of a commercial real estate investment in REITs.
Outside of FFOs, it’s not uncommon for investors to value REITs based one additional merit: dividend yields. Commercial real estate REITs are required by the Securities and Exchange Commission to return a minimum of 90 percent of their taxable income to their shareholders in the form of dividends. Laws are put in place to prevent REITs from funding their own growth in the future with the profits they retain. That said, they can retain profits, which translates into larger dividend yields for those that hold an equity position in a respective company.
I am convinced that REITs are — and will continue to be — a great introduction to the commercial real estate investing world. They are essentially a way to capitalize on the hot commercial real estate market without actually investing in any properties first-hand.
“While the Internet has made it easier for investors to find and buy commercial real estate, these transactions are still more complex and certainly more expensive than a typical residential property purchase,” says Rick Sharga, executive vice president at Auction.com, an online real estate marketplace.
“Real estate investment trusts may be a viable option for investors who’d like to diversify their portfolios by adding commercial real estate, but aren’t comfortable with the complexity or can’t meet the capital requirements that buying commercial properties involve,” he says.
Not surprisingly, more real estate investors are more familiar with the assets they physically invest in than those residing on Wall Street. However, REITs are about to receive some much deserved exposure that will shed some light on their operations. In a move that was announced last year, real estate will no longer reside under the financial section of the stock market with banks and similar institutions, but rather branch off and form its own section.
No later than August 31, the “S&P Dow Jones Indices and MSCI will reclassify and elevate stock-exchange listed real estate companies (including listed equity REITs) from under the Financials Sector to a new 11th headline Real Estate Sector in the Global Industry Classification Standard (GICS).” The move, which will account for the first of its kind since the GICS was created almost 20 years ago, will increase the visibility of REITs and make them more accessible to the public.
This is the sort of thing people interested in learning how to invest in commercial real estate REITs have been waiting for. With its own sector on the S&P 500, real estate will increase its visibility, and financial pundits are convinced mutual fund managers will infuse a lot of capital into the newly formed sector for no other reason than to diversify. The announcement of the move has a lot of people excited, and they should be. Nonetheless, if you are interested in investing in a commercial REIT, now may be the best time to consider doing so. At the very least, these assets can introduce you to what it will take to learn how to invest in commercial real estate.
A commercial REIT may offer an investor a unique way to invest in commercial real estate indirectly. While traditional commercial real estate investments have become synonymous with millions of dollars, a commercial REIT will allow investors to buy into a business one share at a time. As a result, the barrier to entry is considerably lower, and the process is a lot more passive. Perhaps even more importantly, however, is the unique ability commercial REITS have to diversify one’s portfolio. Buy investing in several types of real estate investment trusts, investors may diversify their portfolios and hedge against risk.