By Ben Esget
REIT stands for Real Estate Investment Trust, and is generally a large fund comprised of real-estate holdings.
They typically start out as private partnerships with the hope of eventually becoming publicly traded. REITs often specialize in one type of real estate such as medical, hospitality related, commercial or residential.
From time to time I get asked for my opinion on REITs at large, or to look at a specific REIT.
One of the difficult parts of analyzing a REIT is that they do not trade, so the value is frozen presumably at net asset value (NAV). I say presumably because REITS are only required to reappraise their holdings every few years.
In fast moving markets, this can make reported NAVs all but worthless.
In addition, NAV is usually reported in a way that doesn’t show the total operating, marketing and commission expenses. The regulatory bodies of my industry—the Financial Industry Regulatory Authority and the Securities and Exchange Commission—have recently turned a critical eye on REITs due to this and other issues.
FINRA has released notice 11-44, which proposes NAV to be reported as the net of organization and offering expenses and requires property appraisals to be no more than 18 months old.
Naturally, those in the REIT industry and certain brokers are nervous about these changes, because many investors will find their investments are worth less than they originally thought.
REIT commissions are often north of 10 percent and most real estate is still appraising well off of its highs.
When considering an investment in a REIT, investors should also pay careful consideration to leverage, the debt-coverage ratio and dividend coverage. Most REITs use some form of leverage to enhance the returns of real estate. As with any type of debt, investors should monitor both the total amount of debt used by the fund, as well as the monthly payment needed.
Investors can get an idea of how much debt there is relative to the value of their real estate by looking at the funds loan-to-value ratio. Similarly, the debt-coverage ratio allows investors to ensure the debt can easily be paid with the cash flows from real estate.
Many REITs start paying a dividend on day one, making them attractive to investors. But often times these dividends are funded by new investors.
By monitoring the dividend-coverage ratio, investors can ensure the cash flow from their real estate is enough to cover dividends.
For novice investors, I would recommend staying away from REITs all together. But for those seriously considering this as an asset class, I recommend checking out www.reitwrecks.com, which rates many of the publicly traded REITs.
As a final note, a recent study by the University of Texas and Blue Vault Partners LLC found that most nontraded REITs that go public have underperformed a market benchmark from 1990 to May 15, 2012. For the sophisticated investor who is seeking diversification among real estate and who is ok with illiquidity, a REIT might be appropriate. But retail investors may want to stick with more liquid investments.
Ben Esget is the president of WealthMark LLC, an investment firm in Bellingham. His writes occasional columns for BBJToday.com. Esget also runs the finance blog Outsider-Trading.com, in an effort to level the playing field between Wall Street and Main Street. Contact him at 360-734-1323 or firstname.lastname@example.org.
Author’s note: The information in this column should not be construed as investment advice. Everyone’s goals and investment portfolios are unique. Please contact a financial adviser or an accountant for your particular needs.