Wednesday, September 23, 2009

Income Investing - Real Estate Investment Trusts (REITs)

This is part 2 of 5 on a mini-series based on some of my thoughts about Income Investing.

Read Previous Posting here: Income Investing - High Dividend Yield Stocks

High Dividend Yield stocks are a good way to do income investing as they give out dividends monthly,quarterly or annually. Another good way to do income investing is to invest in Real Estate Investment Trusts or REITs as they are commonly called.

What are REITs?

Real Estate Investment Trusts or REITs are basically like a common stock traded on the stock market just like any other stock. The only difference is that they invest primarily in property and are given tax breaks for paying out a certain amount of their profits as distribution. REITs earn money through the rental income they derive from the properties they own. Investors like REITs for their high dividends (sometimes much higher than those of normal stocks) as well as their defensive nature in a volatile economic climate.

Things to note about investing in REITs

REITs need to secure funding every now and then be it for acquisition projects or simply to refinance their existing loans. In 2008 when the credit crisis was pretty severe, concerns about these REITs getting funding caused many REITs counter to drop in value. Some REITs also had to issue rights so as to raise funding to improve their overall gearing.

When I buy REITs, the things I look out for include the following:

1. Yield - This is similar to the dividend yield that we talked about in the earlier postings. For REITs, I would prefer to have a yield of greater than 5% with the REIT increasing its distributions every year.

2. Net Asset Value - This is the value of all the assets held by the trust. If the price is trading at a discount to the Net Asset Value (NAV), it presents a good buying opportunity.

3. Net Gearing - This determines how leveraged the trust is and how much debt it is taking on. While it might be good to have a low net gearing, having too low a net gearing could mean that the trust is not making enough use of leverage.

4. Parent Company - Some REITs are tied to certain parent companies. These REITs will usually be able to secure funding even during bad times and thus often trade at a lower yield compared to REITs who do not have a strong parent company.

5. Other Risks - Some REITs might be too focused on a certain country (e.g. Japan or Indonesia). Other REITs might be too focused on a certain sector (e.g. office rental space). Should there be a downturn in these countries or sectors, the distributions by the REITs could be affected. Currency risk is also another factor to consider when purchasing REITs. If the REITs receives its rental income in another currency, the depreciation of that currency could affect its distribution.

I currently own a few REITs in my own portfolio. The REITs include First REIT, Suntec REIT and Ascott REIT. I have also been monitoring Realty Income which is listed in the NYSE.


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Read : The 25% Cash Machine
Read: Dividends I have Received Thus Far

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2 comments:

  1. If the investor has a REIT that does not appear when interest rates become unfavorable, can be difficult to liquidate investments to reposition their portfolios. If the REIT is traded, it is easier for investors to put their portfolios according to interest rate movements in the economy.

    HOA

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  2. I like the idea of buying real estate investment trusts. that invest in brick and mortar buildings because you not only get income from the trust you also get captial gains from the increasing value of the real estate that these trusts own. I believe that carefully selected real estae investment trust should be able to out perform stocks over time.

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