REITs: The problem with REITs

Investors and speculators use Real Estate Investment Trusts to make bets on the real estate market. Investors can benefit from REITs. Investors with smaller sums of cash can invest in REITs. This is a significant advantage, as real estate can be expensive, and many investors need help to afford to invest in underlying real estate.

REITs can also be liquidated more efficiently than traditional real estate investments. Investors can diversify their portfolios with REITs. Instead of investing $100 into the same property each, investors can invest $1 in a 100-property portfolio. Investors also benefit from the fact that their liability is limited to the amount of investment they make in a REIT.

Variable Returns

REITs offer a wide range of returns depending on the trust in which the investment was made. To the layman, REITs all look similar. In reality, however, they all have very different portfolios of risk and return.

Some REITs, for example, invest in their real estate assets. On the other side, some REITs lend money to developers to build real estate. The risk and reward profiles of these two REITs are very different. If interest rates rise in the economy, mortgage-based REITs’ value will drop as newer funds can provide higher returns. Equity REITs, on the other hand, will increase in value. Rents increase as interest rates rise.

In addition to equity and debt investment. REITs provide a variety of returns depending on the industries in which they make investments. REITs that invest in commercial property tend to have consistent returns. It is the same for those who invest in medical facilities and hospitals. It is because they are investing in a promising industry.

Some REITs invest in hotels. Other REITs invest in retail properties. These industries need to perform better. In the same way, REITs that have invested in these properties also do not perform well.

Investors must therefore be cautious when selecting the type of investment vehicle they use. The returns they can generate from their investments are affected by many factors.

Time Bound

As an asset class, real estate is not liquid. Investors cannot liquidate real estate at the same rate as other asset classes, such as shares or bonds. The considerable value of real-estate assets is the reason for this problem.

REITs face the same issue. REITs have a time limit. The REIT management must sell the property at the end of a specific period, say ten years. As many REITs reach maturity simultaneously, they can put downward pressure on prices. REITs could also be forced into selling at a time of low prices.

When REITs mature and become more established, new investors often purchase the assets that old investors are selling. When prices drop, finding new investors is difficult, so the properties are sold to pay off the investors.

Increased Fees

Like mutual funds, REITs also collect fees from their clients. They also charge a variety of prices to their clients. The commissions are in addition to the profits earned by REIT shareholders. Investors have expressed concern about the complicated compensation plans of REIT trusts. They charge investors more by adding complexity.

Limited Growth

REITs grow in value sparingly. It is because most of them are structured as pass-through companies. Approximately 90% of the rental revenue REITs generate from these properties is paid to investors as dividends. Only 10% of the rental income is retained, and this too for administrative and emergency expenses. In general, REITs must maintain the number of properties they manage. The price increase is the only factor that can cause any growth.

Tax implications

Because REITs are passed-through entities, they are rarely taxed on a corporate level. The tax treatment may differ depending on where the investment is made. This is the general case around the globe. Dividend income from REITs can be added to an individual’s other income. REIT investors may have to pay up to 37% of their income as tax. Thus, REITs have a higher tax rate than other investments like stocks that only pay a lower rate.

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