Friday, August 9, 2019

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) are companies that own, and in most cases, operate income-producing real estate. REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels and even timberlands. Some REITs also engage in financing real estate. Created by the U.S. Congress in 1960.  REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.

ICF iShares Cohen & Steers REIT ETF 

Symbol  Company     Sector   Dividend ($)   Yield (%)   Market Cap
  • SPG       Simon Properties            Shopping centers   1.40  2.97    58.85B
  • HCP        HCP Inc.                       Healthcare             0.56         5.32      19.65B
  • NLY       Annaly Capital Management                       0.30     11.93  9.49B
  • KRC      Kilroy Realty Corp.        Office                    0.35         1.89  6.47B
  • TCO      Taubman Centers            Shopping centers   0.56       3.07    4.55B
  • MAC    Macerich                                                         0.65      3.12   13.02B
  • SKT      Tanger Factory Outlet Centers    Shopping centers    1.40  6.15  2.266B
  • AHH      Armada Hoffler Properties  / Apartments   0.17     6.47  417.31M

  • CHSP     Chesapeake Lodging Trust       Hotels        0.35       4.24   1.95B
Chesapeake Lodging Trust (CHSP) was acquired by Park Hotels & Resorts (NYSE:PK) for $2.7 billion. (6 May 2019)

Park Hotels & Resorts (NYSE:PK) has enterprise value of $12 billion, making it the second largest lodging REIT behind Host Hotels & Resorts (NYSE:HST), with a $17 billion enterprise value.

Park Hotels & Resorts (NYSE:PK): 84 percent of the portfolio will be comprised of Hilton-operated hotels, with 11 percent operated by Marriott, and less than 5 percent by Hyatt. 

Types of REITs. There are two broad categories of real estate investment trusts: equity REITs and mortgage REITs. Most REITs are equity REITs, which own or operate income-producing real estate, such as apartment buildings, offices or shopping centers.

Equity REITs typically invest in a particular type of property. For example, 
  • Retail REITs (approx. 24% of all REITs) invest in shopping centers
  • Residential REITs invest in apartment complexes, single-family homes, student housing. 
  • Healthcare REITs invest in the real estate of hospitals, medical centers, nursing facilities, and retirement homes. 
  • Office REITs invest in office buildings.
There are also more obscure equity REITs such as:
  • Lodging and resort REITs, which invest in hotels and resorts
  • Self-storage REITs, which invest in storage facilities
  • Data center REITs, which invest in data storage centers
  • Infrastructure REITs, which invest in infrastructure, such as pipelines and cellular towers
  • Industrial REITs, which invest in facilities such as distribution centers and warehouses
  • Timberland REITs, which specialize in harvesting and selling timber

If a REIT invests in a mix of property types, it's called a diversified REIT. If the properties it owns and manages don't fit into any other category, it's called a specialty REIT.

Mortgage REITs finance commercial and residential properties by investing in mortgages and mortgage-backed securities. These can be agency mortgages (secured by Fannie Mae, Freddie Mac or Ginnie Mae), non-agency mortgages, or commercial mortgages. Mortgage REITs typically specialize in either commercial or residential mortgages, but some invest in both.

How REITs work. To qualify as a real estate investment trust, companies must meet certain guidelines set by Congress. In short, the company must:
  • Be considered a corporation under the IRS revenue code
  • Be managed by a board of directors
  • Be held by at least 100 shareholders, with no fewer than five holding 50 percent of shares
  • Invest at least 75 percent of assets in real estate, cash or U.S. Treasurys
  • Derive at least 75 percent of income from real estate
  • Have 95 percent of income be passive, which is income that doesn't require direct action from the corporation, such as rental payments
  • Pay out at least 90 percent of its taxable income to shareholders through dividends
As long as it satisfies these requirements, a REIT is exempt from corporate taxes. So unlike a typical corporation, which has to pay taxes on earnings, a REIT's income is not taxed, leaving more money to pass on to shareholders. That's why you'll sometimes hear REITs referred to as pass-through investments. Investors still must pay taxes on most of the dividends at their ordinary income tax rates. However, as a result of tax reform, investors can deduct 20 percent of income from pass-through investments, lowering the maximum tax rate on REIT dividends from 39.6 percent to 29.6 percent.

The chart below tracks the price performance of the NAREIT All Equity REIT Index going back to the early 1980s (in blue). It compares the index to the Federal Reserve’s targeted Fed funds rate (in orange). Periods of extended tightening are highlighted in the blue columns.

We’ve had five periods of extended tightening since 1981. In three of them, REIT prices did indeed suffer. But in the other two – or a full 40% of the total – REIT prices did very well. In fact, the last tightening cycle in the mid-2000s coincided with one of the greatest bull markets for REITs in history.

As for today, most of the hurt in the REIT sector that comes with a rate hike has already been priced in. That’s because this is the most telegraphed Fed tightening in history. Yellen has been preparing us for this day for months. Investors who wanted to sell, for the most part already have.

So as a result, income-focused investments like REITs have had a terrible year. After topping out at $89.27 per share in late January, the Vanguard REIT ETF (NYSEARCA: VNQ) fell to as low as $74.67 by late June. That’s a decline of 16%, based almost exclusively on Fed fears.

But since then, REITs have been making a comeback, up about 6%. For the reasons we’ve explained, we expect that modest momentum to continue, with or without a Fed hike. 

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