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Real Estate Investment Trusts (REITs) by Jordan at Investing Blog

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With the credit crunch and real estate bubble pop coming to a close while yields plummet to record lows, investors are again looking back into real estate investment trusts as a way to generate income with cashflow producing real estate. If you like dividend income, you’ll love REITs!

A real estate investment trust is a special tax designation that allows a corporation to pass along earnings to shareholders without first paying corporate taxes. Avoiding double taxation is in many ways what makes real estate investment trusts so much more lucrative than direct holding of real estate, or derivative investments like homebuilder stocks. For all intents and purposes, a REIT is to real estate what an exchange-traded fund (ETF) is to stocks.

There are literally hundreds of REITs in existance, both public and private. Private REITs are commonly owned by private-equity firms and investment banks for long term dividend income. Public real estate investment trusts, however, are often purchased for their cash flow as well as appreciation. Many REITs topped the charts during the 2003-2007 boom as the best performing securities.

What to Look For

Real estate investment trusts are evaluated on three different criteria.

The first is Net Asset Value, or the value of the assets in the trust divided by the number of shares. When the per share price is higher than the NAV, the REIT is said to sell for a premium. When the per share price is lower than the NAV, the REIT sells for a discount.

Next is the adjusted funds from operations figure, or AFFO. Funds from operations is considered to be Net Income + Depreciation + Amortization minus the gains from sales of assets. This is the most simple form of cash flow analysis for any REIT.

Finally, we have cash available for distribution, or CAD. The cash available for distribution is very simply the AFFO figure minus any operational expenses. If a REIT took in $1 million in AFFO and had $100,000 in operational costs, it would have $900,000 in CAD. Simple, really.

Income Machines

By law, real estate investment trusts have to be cash flow machines. Each year, 90% or more of all taxable income must be passed on to shareholder in dividend payments.

In order to be more attractive to investors, many REITs have switched to monthly dividend payouts to allow for more aggressive compounding. Many, though, still rely on quarterly payouts to reduce transaction costs and to be more accurate in their disbursements. Regardless, with 90% of the cash flowing out each year, there is plenty of income to be had with REITs. Don’t discount capital appreciation, either.

Real estate investment trusts are almost always unleveraged. So, where you might be able to leverage up at a rate of 5:1 or higher with your own private investments, REITs are usually no more than 80-90% invested. However, since most REITs buy larger properties and units by the thousands, these income properties usually provide better capitalization ratios than smaller properties an individual investor might hold on his or her own.

About Jordan

Jordan is the web master of www.investingblog.org, a site dedicated to skillful investing, news and recent trends. You can read the original article here.

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