• REAP

Pros and Cons of REITs

Photo credit to Jason Strull from Unsplash

Recently, investors show increasing favor to REITs. REAP summarizes some advantages and disadvantages of REITs.


Pros of REITs

1. Amount of money needed? Characteristics of REITs?

A Smaller amount of capital involved, more flexible, and simpler. Due to the nature of real estate investment (high barrier to entry), most investors can’t even enter this promising market. REITs change real estate investment into a securities investment, which reduces investment threshold and operation difficulty. This change gives small and medium investors access to non-residential real estate investment.

2. What is the liquidity of REITs?

Comparatively high liquidity. REITs reflect the value of the real estate through securitization. Normally, security will be traded in securities market after issued. Trading in the market improves the liquidity and monetization process of REITs.

3. What do you get from REITs?

Relatively stable earnings and dividends, with certain growth potential. REITs mainly rely on rent collected from investment properties. In most cases, 75% of the rent will be used for dividends. Thus, when compared to other financial products, REITs have relatively stable earnings and dividends. Besides, REITs have growth potential because of the increment of rents and fair value of the property.

4. Relationship with stock and bond?

Low correlation with stock or bond, diversify the investment portfolio. The yield/risk characteristics of REITs lie between stocks and bonds, while correlations are low. For example, in the US market, the correlation between REITs and stocks is between 0.2 ~ 0.45. The correlation with bonds is even lower, typically between -0.2 and 0.15. Therefore, many investors are willing to add REITs to the investment portfolio to diversify risk.

5. Other pros?

Strict supervision and transparent information. REITs is a relatively safe product due to the same supervision and information disclosure standard as listed companies.

Cons of REITs

As an investment, REITs also have some disadvantages. Risks of REITs mainly include:

1. Think about the whole picture?

The overall economic environment. Due to the global pandemic, 44% of Amercians are working from home, causing a high vacancy rate in commercial properties. This affects the returns of REITs.

Photo credit to Ian Harber from Unsplash

2. One of the most annoying characteristics of real estate investment?

Cyclical risk of real estate. Real estate is a cyclical asset, any real estate derivatives may encounter periodic price fluctuations.

3. Ever think about policy change?

Policy-related risks. The debt-bearing ratio and valuation of real estate under REITs may be affected by changing laws, tax systems, and accounting systems. In addition, new adjustments of local construction planning may directly affect the value of the real estate under REITs.

4. Can you trust your asset manager?

Investors do not directly own the real estate since they invest through REITs, therefore, they generally don’t have a say in either property operation or management. If the asset manager does not operate the property well, or even worse, he or she is taking advantage of investors, except for selling REITs and exit, there is no means for investors to directly intervene.

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