Commercial Properties REITs

REIT is an abbreviation for Real Estate Investment Trust. "Commercial Properties REIT" (CPR) essentially refers to an investment trust comprised of only commercial real estate. 

It is a pool of funds from multiple entities invested in high-value commercial property.

These are like mutual funds, where the underlying asset is real estate and whose growth drivers are primarily rental yield and capital appreciation.

These are also traded in an open share market.

There are two main types: 

1. Equity 
2. Mortgage 

As of the 2nd quarter of 2021, REITs have outperformed US stocks if we look at the last 10- and 20-year historic rolling data regarding both returns and volatility.

However, there is a caveat: the analysis undertook the collective value of all the REIT types (discussed later in this article). As a result, certain kinds of REITs have performed differently.

What qualifies as a REIT?

Not just any fund can qualify as a REIT. However, some general requirements are essential for a trust to be classified.

• Net Asset Value (NAV) must be declared twice every financial year.
• 90% of the income (primarily rental yield and capital appreciation) must be distributed to investors as dividends.
• A board of directors or trustees.
• Five or fewer individuals may hold no more than 50% of its shares.
• 80% of funds must be invested in properties capable of generating revenues.
• It would help if you were an entity that would be taxable as a corporation.
• At least 75% of revenues must be generated from passive channels, such as rent, interest, etc.

How Does it Work? 

Commercial REITs work in a somewhat similar way to mutual funds. 

The commercial property REIT industry offers a diverse range of properties at diverse locations with various strategic advantages.

CPRs also provide liquidity, which can convert any investments in any CPR into cash in the short term.

CPRs expose their investors to real estate by putting bets on properties like offices, restaurants, shopping centers, condominiums, and hotels.

Primarily, these trusts profit from their investors through rental yield and capital appreciation property.

These typically have two general categories of growth:

1. First, internal growth refers to the development of revenues through an existing asset base, such as by increasing rents.
2. External growth can be attributed to the asset base of the REIT, which occurs when, for example, buying new real estate.

Because REITs have to pay the majority of revenue to shareholders, they usually fund through external sources, such as issuing new shares or raising debt.

Keeping this in mind, even though it's far easier for a REIT to offer shares and raise funds, an investor or analyst needs to ensure that the REIT is performing reasonably on a per-share basis.

How do I Invest in these?

Let's understand this with the help of an example, 

Let's say you have a spare $25 and want to grow it in the capital markets. So you give this money to a fund manager through the equity markets using a Demat account with an authorized broker. 

Alternatively, you could invest an amount as low as $25 into real estate assets through REITs in a similar method as a mutual fund.

With a mutual fund, the money you invest is kept in the pool of funds by the fund manager. The fund manager will evaluate the best stocks and invest the collection of funds in those stocks. 

Similarly, A REIT manager will look for the best property/properties (in the context of this article, commercial property) and invest the pool of funds into it.

Investors are not responsible for any legal or tax-related formality. Also, the maintenance, collection of rentals, and other responsibilities are not supposed to be taken care of by investors.

Hence, the procedure for investing in REITs is as transparent and straightforward as investing in the stock market.

What are the types?

There are several types of REITs:

• Office
• Timberland 
• Retail 
• Lodging 
• Datacenter 
• Healthcare 
• Self-storage 
• Infrastructure 
• Diversified 
• Specialty 
• Residential 
• Industrial 
• Mortgage

However, the top CPRs invest in the following:

• Office buildings
• Hotels
• Industrial buildings
• Retail stores
• Specialty property

How to assess?

Today, as an investor or analysts, we have multiple metrics and formulas to evaluate a company's stock. Similarly, the following are some essential and popular metrics to assess a REIT.

1. FFO 

This is the primary metric used to assess.

FFO stands for Funds from Operations, and it is an important metric when it comes to evaluating real estate companies. It indicates the net income or loss the firm makes from its operations.

The formula for FFO:

Funds From Operations = Net Income + Depreciation and Amortization + Losses on Property Sales - Gains on Property Sales - Interest Income.

To better understand this metric, refer to the hyperlink and check out Page 57-59 in this 10-K filing from Tanger Outlets (one of the REITs Warren Buffet invested in).

 2. Credit Rating

Below is the screenshot of Store Capital, another company in which Warren Buffet is invested. To find the credit rating of any company, log into Moody's website and search.

Source: Moody's.com

A credit rating essentially represents the ability of an entity to pay off a loan on time. It is used when deciding whether an entity should get a loan and at what interest rate.

A company with a high credit rating can take out debt swiftly and at a low-interest rate, allowing for business expansions whenever required. That is why it is a notable metric to assess any REIT.

3. Adjusted EBITDA, EBITDAre, Adjusted EBITDAre

EBITDA stands for Earning before Interest, Taxes, Depreciation, and Amortization. EBITDAre and adjusted EBITDAre are the modified versions of the EBITDA metric. 

EBITDAre stands for Earnings Before Interest, Taxes, Depreciation, and Amortization for real estate.

The two metrics suit the evaluation methods applied to REITs and the real estate industry. 

For a better understanding of these metrics, please refer to the hyperlink and check out Page 62-63 in this 10-K filing from Tanger Outlets

Advantages and Disadvantages

Some of the advantages and disadvantages are listed below. These factors should all be considered when investing in one of these trusts. 

Advantages

• They provide a convenient and affordable way for individuals to make real estate investments.
• They provide an easy exit for investors, i.e., they are liquid assets.
• The system to invest in them is transparent and easy to use.
• They have a comparatively higher rate of return; as stated above, REITs are legally bound to distribute 90% of profits to shareholders.
• Investors do not have to deal with the general management of properties, legal issues, taxation, and other formalities.
• They provide exposure to properties of different natures, locations, etc.

Disadvantages

• They are highly dependent on the economy. For example, recently, because of COVID-19, when the world went to work from home, the value of some commercial REITs plummeted. 
• They are somewhat dependent on the infrastructure policies of the owned real estate nations.
• The dividend taxation levied on unitholders/investors is comparatively higher than the average investment vehicle available in the market.
• The fund manager's commission is also higher than the average investment vehicle available in the market.
• Its dependency on the economy makes it difficult for management to control market performance. Many publicly-listed companies aren't nearly as exposed to economic downturns.

Commercial Properties vs. Residential Properties

Commercial REITs vs. Direct Investment in commercial real estate

Difference Between REITs and Real Estate Mutual Funds

Researched and authored by Dhanraj Johari | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

Free Resources

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