Hi I'm Jimmy in this video.
We're going to look at real estate
investment trusts or REITs
for short.
So we're gonna look at the basics of
what a REIT is how
they're set up how we can
value them and then throughout
the whole process we're going to
mention a few quick examples
just to illustrate how wide
ranging this type of real estate
investment can really be.
OK so let's start with the very
basics.
What is the REIT.
Well as I mentioned REIT is short
for real estate investment trust.
Most of the time REIT's own
and manage actual real estate
properties things like apartment
buildings office buildings
shopping malls or shopping centers
hotels maybe warehouses
or data centers.
And then there is some specialty
types of REITs and what they do
is they invest in mortgages but
we'll come back to that one in a
minute. So where do REITs come from
well back in 1960 the Real
Estate Investment Act was passed by
Congress as a way to allow for
smaller investors to be able to
invest in real estate
without needing large sums of money.
That is often needed to invest in
commercial properties or large
scale residential properties like
apartment buildings.
Well with the formation of
REITs us investors can now buy a
piece of a real estate investment
portfolio just like we
would buy a piece of a typical
company with a stock.
OK so beyond giving us access to
larger real estate investments
REITs also have some tax advantages
that make the typical REIT
dividend much higher than
most stocks.
So a company that's setup
as a REIT doesn't have to pay
any corporate income tax as
long as they follow a few rules.
First they have to pay out at least
90 percent of taxable profits
to shareholders.
Now instead of calling their
payments dividends with
REITs they typically call them
distributions.
But the case of this video I'm going
to use them fairly interchangeably.
So the next thing that a REIT has to
do is that they have to have at
least 75 percent of all of their
assets in real estate
or in loans backed
by real estate like mortgages
plus at least 75
percent of their gross income must
come from real estate related
activities either the interest
from mortgages or rental
income from actual property
is just as an example.
OK so there are a few main
classifications for REITs.
They have equity REITs and as
we the probably guess equity rates
invest in hard assets like
apartment buildings or office
buildings.
So what they're doing is they're
buying actual real estate
properties.
Now most REITs fall
into the equity REIT category
now generally equity
REITs tend to focus on
specific real estate investment
types.
So you might get a health care
equity REIT like Omega
Healthcare which owns nine
hundred or so long term
health care facilities in the United
States.
And basically what they do is
that they buy properties from
existing health care businesses
and then they lease those properties
back to that health care company.
In theory this frees up the health
care company from having to worry
about managing the real estate
itself.
And it allows Omega to pay
its 7 percent or so distribution
to its shareholders or maybe
it's an equity REIT that focuses on
office buildings like easterly
government Properties which owns
mostly office buildings that are
leased to government agencies.
In their case mostly federal
government agencies and that
real estate is ultimately what fuels
their 5 percent or so dividend
that they pay.
Now just to be clear I'm not
bringing out these companies as
examples of REITs that I like.
I'm just using them as an example
to illustrate how wide
ranging these
equity REITs are.
OK so now we could jump into our
next type of REIT which is the
mortgage REIT.
And as you may guess mortgage
REITs invest mostly in mortgages.
So basically a mortgage REIT
will own the debt.
On real estate.
And an example of this type of thing
might be something like two harbors.
And what they do is they focused
mostly on the financing
behind residential properties
primarily using mortgage backed
securities or maybe were
more interested in a company like
Apollo commercial real estate
which as the name implies invests
in commercial real estate mortgages
and mortgage backed securities.
Apollo has a distribution
rate of about 9 or
10 percent while two harbors
has an even higher dividend rate.
Now the question is do we think
that this type of distribution level
is sustainable.
Well in order to figure that out
we're going to do a deeper dive into
those companies but
this is an illustration of how
high of
REITs in general can be.
When you think about how it is
compared to the S&P 500
let's say which is close to the 2
percent level.
Now let's imagine we do want to do a
deeper dive into a REIT.
We go ahead and value our REIT.
Well the first thing that we need to
know is something called the funds
from operations.
And this is very similar to net
income for a traditional company
although it's not exactly the same
thing. We could say it's sort of
like net income with some
adjustments specifically for
the real estate world of investing.
So how do we calculate funds from
operations.
It's actually quite simple.
We take net income and then we
subtract any profits
on the sale of real estate that we
have. And then we add back
the losses on any real estate sales
that we have.
And then we add back impairment
charges and then we add back
any real estate related depreciation
and amortization and then boom
just like that we have funds from
operations.
Now this is important because now
we have something to compare the
price of the REIT to.
So we can take the funds from
operations.
They might also call this FFO for
short while we take FFO
and we divide that by the number of
shares outstanding.
And this will give us the FFO
per share.
Now we can apply.
We can take the price of the
REIT divide it by FFO per share
and just like that we have price
to FFO.
Now this could be very similar you
could look at this in the same way
that you'd look at price to earnings
or PE ratio.
Now we can also normalize funds
from operations by removing
one time charges or gains.
Now many investors prefer to use
something called adjusted funds
from operations or AFFO
for short.
Well basically what that does is
it tries to create something similar
to free cash flow but this time
for REITs now this
is done by making a few more
adjustments like getting rid
of capital expenditures and then
they adjust some accounting
rules around the way rents
are accounted for and new properties
are accounted for.
So FFO can be a great starting
point and a great way to value
REITs but one of the best possible
ways to value a REIT is something
using NAV or net
asset value.
Basically the goal here is to try
to calculate what
at least ballpark what the
underlying real estate assets are
actually worth.
Now this can be a bit tricky to do
since companies don't report these
types of numbers and
this is really something that
investors like to do because
the theory is if we could value the
actual real estate then
we wait for the price to fall below
that the value of that real estate.
In theory we should get a great
deal. So as we could see there are a
lot of different ways to value
REITs and a lot of different tools
and tricks to analyzing them.
And there are some good advantages
to REITs like they tend to pay
pretty good dividends and
they do a pretty good job of giving
us access to the real estate market
even if we only have a small amount
of money to invest.
And it also helps us diversify our
portfolio into an asset class
that perhaps we wouldn't have
exposure to if this type
of fund wasn't set up.
On the flip side one thing we should
keep in mind about REITs is
revolves around their stock issuance
so many times REITs will have
to do secondary stock offerings
to raise additional capital since
they're paying out the majority of
their profits if they ever
need to make new acquisitions or
clean up their balance sheet.
Oftentimes they have to issue more
shares to get the cash
that they need and that might
not always be the best thing for
shareholders.
So that's something to consider at
least on the negative side.
Now regarding the dividends that
REITs end up paying well
REITs tend to have fairly stable
dividend distributions
and while this can be a good
thing for real estate investors
who are looking for a steady
stream of income now that's not to
say that the value of the stock
itself or the value of the REIT
itself doesn't swing around like
every other stock it does.
Sometimes they're more volatile than
typical stocks but
their distributions tend
to be fairly stable and this could
be a good thing for investors who
are relying on a steady stream of
dividends.
So that's the basics of
REITs and the some of the advantages
and disadvantages of them.
Now I recognize that this was a very
simple look at REITs
and if reads is something that you'd
be interested in seeing more of.
Please let me know in the comments
below.
Then we can either go into the
industry a bit deeper that if we
think that would be interesting or
perhaps it would make more sense to
dive right into individual
REITs and get our exposure to the
entire industry that way.
Let me know which one you think
would be more interesting and if
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It's the thumbs up.
And I'd like to thank you for
sticking with me all the way to the
end of the video.
I'll see in the next video.
Sorry you made this so short but
I'm not sure if people are really
interested in this type of thing.
So if dividends from REITs is
something that interest you let me
know in the comments below we'll do
more extensive looks at this.
Thanks and I'll see in the next
video.