Everything you need to know about REIT

What are REITs?

What are REITs? REIT is an acronym for Real Estate Investment Trust (REIT), which can be defined as a company that owns and operates real estate that is income producing, as well as owning assets relating to real estate. In 1960, Congress established REITs to allow investors and individuals the ability to invest in wide-ranging and large-scale income producing properties. REITs differ from other real estate investment types because REITs are required to develop and acquire investment properties with the purpose of operating them as part of an owned investment portfolio, whereas typical real estate investors resell properties after they have been developed or renovated, and/or after holding an investment for a profitable period. Income producing properties own and operated by REITs include a range of property types, such as apartments, shopping malls, hotels, manufacturing warehouses, office buildings, in addition to mortgages and mortgage-backed securities. Majority of REITs prefer to specialize in a specific property type, for instance, retail properties. There are multifamily REITs, office REITs, Retail, and REITs that specialize in healthcare facilities, in addition to others. REITs provide a way in which individual investors can reap the benefit of earning a portion of income produced through the ownership of commercial properties, without having to go through the process of purchasing one.

Types of REITs

REITS can be categorized as mortgage, equity, or hybrid. Most REITs are equity REITs, which normally operate and own income producing properties. Conversely, mortgage REITs provide real estate owners and managers with money directly as loans or mortgages, or indirectly as the purchase of mortgage-backed securities. Mortgage REITs on average, rely on more leverage than equity REITs, as they rely more on borrowed capital. In addition, mortgage REITs typically manage their own credit risks and interest rates through derivatives and other types of “hedging” techniques. Hybrid REITs are companies that utilize a mixture of investment type strategies from mortgage and equity REITs.

Public REITs, whether mortgage, equity, or hybrid are registered with the U.S. Securities and Exchange Commission (SEC) and are traded publicly on the stock exchange. REITs that are registered with the SEC but are not publicly traded are called non-traded REITs or non-exchange traded REITs.

Publicly Traded REITs

Publicly traded REITs differ from non-listed REITs in several ways. Publicly traded REITs are also referred to as listed REITs and are more liquid because REIT shares are traded and listed publicly on popular stock exchanges. Brokerage commissions are also the same as for other public traded stocks, and rules governing stock exchange require directors to be separate from management. In addition, Nasdaq and NYSE rules require independent nominating, compensation committees, and fully independent audit. In addition, the minimum investment amount for a listed REIT is one share and market prices are publicly available in real-time, as well as a range of analytic reports. Public REITs are also managed by company employees, and specific exchange rules are in a corporate governance.

Public Non-Traded REITs

A public non traded REIT files with the SEC, but their shares are not publicly traded on stock exchanges and are also referred to as non listed REITs. This causes shares to be more illiquid and share redemption programs do differ with respect to the company and are very limited on average. Individual investors typically must wait a number of years (typically 10) to receive a return on their investment until the company chooses to engage in a public transaction, such as listing shares on a stock exchange or liquidating company assets. Public non traded REITs broker commission differs as well. Fees are a typical 9% to 10% of the investment, as well as other upfront costs, management fees, and back-end fees may also be charged. Public non traded REITs also typically have no employees, a third party manages the company, and corporate governance is subject to North American Securities Administrators Association (NASAA) guidelines and state guidelines. In addition, many states have adopted NASAA guidelines and require majority directors to be separate from management. Public non-traded REIT share values are not transparent. Independent information concerning share values is typically not available. Although, companies may provide share values one and a half years after an offer has transpired.

Non traded REITs performance has been under scrutiny over recent years due to its illiquid nature, lack of valuations, and governance issues. According to the Gilbert, Ariz., a research company that tracts non-traded REITs, asserts that 2017 marks the lowest capital-raising activity over the last 14 years. According to Commercial Real Estate Direct, non traded REITs performance was up 11.3% during the fourth quarter, from the third quarter of 2017, bringing capital rising for 2017 to $3.9 billion, per the “Summit Investment Research” company. In contrast to 2016, in which non traded REITs raised $4.8 billion, approximately 23% more than 2017 figures.

Private REITs

Private REITs, also known as a private-placement REIT are non-traded and non listed REITs that are typically associated with strong risks. Private REIT requirements differ from other REITs because they are exempt from registration according to the Securities Act and are not subject to the same disclosure and requirements that non-traded REITs are subject to, making it very difficult for investors to get a sense of value or make an informed investment decision. Accredited investors and investors with an excess net of $1 million are generally the only groups that can buy private REITs, which makes them least popular. Private REIT requirements differ from listed REIT investments as they are less strenuous and unlike public REITs, such as venture capital funds and hedge funds, which do not necessarily have to give prescribed disclosures to accredited investors. The concept behind an accredited investor relies on the ability of a private REIT investor to bear any economic risk of investing in unregistered securities.

REIT Investment Caution

Like with any investment, with REIT investments one should take one’s own financial situation into account, consult a financial adviser, and do thorough research prior to making any type of investment. Public REITs’ quarterly and annual reports, offering prospectus, and disclosure filings are available for review at www.sec.gov. Public non-traded REIT investments that are listed on major stock exchanges can be purchased through a stockbroker, as with other publicly traded stocks. Non-traded shares can also be purchased from brokers, but brokers must have been engaged in the participation of the REIT offering. REIT exchange-traded fund and REIT mutual funds are also an option for investment. It is important that one understand the risks associated with different investment strategies prior to backing an investment in any type of REIT.

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Commercial Real Estate Definitions and Terms

As a real estate investor, it is crucial that your understand all of the important commercial real estate definitions and terms.  We have listed some of the most common and fundamental commercial real estate definitions as a quick reference below:

Absorption

The absorption rate represents the rate in which units are leased in a specific real estate market or area.  Absorption is calculated by dividing the average number of units per month by the total number of units available.   For example, we figure out that 1000 units has been leased in a 12 month period.  We take the 1000 units divide 12 months then lastly divide the rate into the number of active units to get the absorption rate of your market area. If a apartment building had 10,000 square feet of new leases in 2017 and 2,000 square feet of tenants leaving, its positive net absorption is simply 8,000 square feet.  The absorption can be calculated for a singular building or by an entire market.

Accrued Interest

The interest on a loan that accumulates during the loan period and paid at the end of the loan term.

Capitalization Rate (Cap Rate)

The capitalization rate is the percentage of your funds that paid for the project that comes back to your annually.  For example, if you purchase a commercial real estate property for $500,000 that return $50,000 annually, your cap rate is simply 10%.  The standard calculation for Cap rate is NOI / Price.

Cashflow (process)

Cashflow is the net amount of cash and cash-equivalents moving through the commercial investment property.

Cash-on-Cash Return

A cash-on-cash return is the percentage of monies invested in a building that is returned to an investor annually of financing payments have been made. The cash on cash return is usually higher than the capitalization rate, with favorable terms.

Contract Rent

Contract rent is the dollar amount of the rental obligation that was specified in the lease, also referred to as face rent.  Contact rent is determined by the square footage in a commercial real estate property.

Debt service coverage ratio (DSCR)

The DSCR is a measurement of cash flow available to pay current debt obligations.  The ration is the net operating income in a multiple of debt obligation due within one year; includes interest, principal, sinking-fund and lease payments.

Interest Rate

The rate used to determine how much the money will cost to borrow over time.

Interest only Period

An interest only period is when the borrower is only making interest payments to the investors or loan for a set period of time.   At the end of one of these periods, the borrower is usually required to satisfy the loan principle with a balloon payment, re-amortize the loan, or the property has been sold.

Market Rent

Market rent is the accepted price to lease a space for residential or commercial purposed.  For example if a 1,500 square foot apartment is listed for rent for $3,000, it is because similar spaces in the local market are also leasing at this price.  Investors use market rent to discover opportunities in local markets to increase rents and profits.

Mixed Uses Development

Mixed uses development is the use of a building or several building for more than a singular purpose.  An example of this type of commercial real estate development would be a condo building with a Starbucks and a bagel shop at the base of the condo building.

Multifamily Real Estate

Multi-family residential real estate is a classification of housing where multiple, separate housing units for residential inhabitants are all contained within a single or several building within one complex.  Commonly referred to as an apartment building.

Net Operating Income (NOI)

The net operating income or NOI is the measurement used to analyze real estate investment that generate income.   NOI equals all revenue from an investment property minus operating expenses.  NOI normally appears on the investment property’s income and cash flow statements.  When the NOI is negative, it is usually referred to as the net operating loss (NOL).  NOI helps real estate investors compare different investment properties they may want to buy or sell.

Offering Memorandum (OM)

An offering memorandum is a legal document that states that objectives, risks, and the terms of the real estate investment to the investors.  The OM serves as a guide to provide the buyers or investors with information on the real estate offering and to protect the seller from the liability of selling unregistered securities.

Occupancy

The occupancy rate refers to the percentage of occupied units in a commercial real estate property.  The occupancy can be determined in building or in the market.

Preferred equity

A preferred equity stock is a type of ownership that has higher claim on its assets and earning than common stock.  Preferred equity generally have a dividend that must be paid out to investors be for any common shareholders including the owner of the asset.

Preferred return

The preferred return or “pref” is a confusing term in regards to real estate investing.   It is commonly described as the claim on the profits given to an investor on an investment opportunity.  Usually when the profit percentage is reached, the excess profit is split among all of the investors as agreed.  This is the most common type of return used in real estate investments.

Private Placement Memorandum (PPM)

A private placement memorandum or PPM is a ledge document provided to investors to sell stock in relationship to a real estate business.  The PPM describes the company selling the security, terms of offering, and the risk of the investment.

Pro Forma

A pro forma is a method that is used to calculate financial results.  The pro forma places significant emphasis on present or projected figures.

Rent Roll

The rent roll is a document that provides a snapshot of the current income representing the owner’s asset.  The rental income derives from an income producing real estate asset.

Trailing 12(t-12) or Profits and Lost

A real estate investment’s trailing 12 represents its financial performance for a 12 month period, but not the fiscal year.  The t12 is calculated by adding together all four quarters.  The T12 helps determine the overall value of a multifamily asset and the income it brings.

Vacancy

The vacancy rate refers to the percentage of unoccupied units in a commercial real estate property.  Similarly to occupancy, vacancy can also be determined by the building or the entire market.

So there you have a short list of the most important commercial real estate definitions and terms.  I hope these terms will help you in evaluating any commercial real estate investment, especially within the multifamily residential real estate.  If you have additional terms you would like us to add, feel free to reach out to us at info@realtyevest.com. or you can check out investopedia for more real estate investment terms and examples.

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