REIT Investment Basics

In [10], Charles Schwab provides the case for REITs.  Here are the four reasons why REITs might deserve a place in your portfolio:

1. Diversification
• REITs rarely perform in lockstep with stocks or bonds due to the below reasons:
• In recent years, the divergence was partly the result of low interest rates, which caused yield-hungry investors to drive REIT prices higher.
• REITs tend to follow the real estate cycle, which typically lasts a decade or more, whereas bond- and stock-market cycles typically last an average of roughly 5.75 years.
2. Income
• In 2018, U.S. REITs yielded 4.88%.
3. Inflation hedge
• Real estate has tended to fare well in the face of rising prices.
• REITs with commercial holdings frequently have agreements that allow them to raise rents in tandem with inflation.
4. Long-term growth

If you choose to invest in REITs, do consider the following factors:

• REITs are poor investments during periods of increasing interest rates, when rising yields from fixed income investments make REITs--which are risker--less attractive.
• REIT dividends typically aren't treated as qualified dividends and will generally be taxed at higher ordinary income tax rates.
• Because REITs tend to be volatile, they should constitute no more than 5% of your portfolio.^[10]

What's a REIT?

A real estate investment trust (REIT) is

• A company that owns, and in most cases operates, income-producing real estate. 
• REITs own many types of commercial real estate, ranging from office and apartmentbuildings to warehouses, hospitals, shopping centers, hotels and timberlands. 
• Some REITs engage in financing real estate.

What are the different types of REITs? REITs can be:

• Equity REITs
• The majority of REITs are publicly traded equity REITs. Equity REITs own or operate income-producing real estate. 
• In November 2014, equity REITs were recognized as a distinct asset class[6] in the Global Industry Classification Standard by S&P Dow Jones Indices and MSCI. 
• mREITs (or mortgage REITs) 
• Provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities and earning income from the interest on these investments.
• In [7], Jussi Askola claimed that mREITs (vs. Equity REITs) are quite different businesses and carry more risk.
• In [6], Chuck Carnevale commented that Annaly Capital Management (NLY), Dynex Capital, Inc. (DX), and  AGNC Investment Corp. (AGNC) are not desirable for your retirement portfolios.
• Public Non-listed REITs 
• Public, non-listed REITs (PNLRs) are registered with the SEC but do not trade on national stock exchanges.
• Private REITs 
• Private REITs are offerings that are exempt from SEC registration and whose shares do not trade on national stock exchanges.  Do read [11] before you invest in private REITs.

The two main types of REITs are:

• Equity REITs
• mREITs  

The key statistics to examine the financial position and operation of a REIT are:

• Net asset value (NAV)
• According to NAREIT, REIT share prices are currently trading at a premium over NAV of 12%.  In [6], Arturo Neto concluded that REITs are solid investments. But, they're looking pricey now (09/20/2019).
• Net Operation Income (NIO)
• Funds from operations (FFO)
• Is a better indicator of a REIT's performance than the more traditional earnings per share reported by most other companies; in other words, FFO is to REITs what EPS is to other companies
• Adjusted funds from operations (AFFO).

How does a company qualify as a REIT?

To qualify as a REIT a company must:

• Invest at least 75% of its total assets in real estate
• Derive at least 75% of its gross income from:
• Rents from real property
• Interest on mortgages financing real property 
• Sales of real estate
• Pay at least 90% of its taxable income in the form of shareholder dividends each year
• Be an entity that is taxable as a corporation
• Be managed by a board of directors or trustees
• Have a minimum of 100 shareholders
• Have no more than 50% of its shares held by five or fewer individuals

Table 1.  REIT preferred stocks paying roughly from 6% to 8% yield

Preferred REIT  

REIT preferred stock is a type of hybrid security with both equity- and bond-like characteristics. Within the capital structure of REIT companies, preferred stocks have a senior claim to earnings and dividends versus common stock but are generally junior to corporate bonds.

In [2], it states that REIT preferred stocks can:

• Provide essential stability to a retirement portfolio.
• Provide an effective path to withdrawals if you use them in a ladder
• Excel in the expected flat or bearish bond markets
• Be secure if History and logic imply that well-chosen

and it also provides a list of REIT preferred stocks paying roughly from 6% to 8% yield in Table 1.  You can consider them a starting point with due diligence.  Besides an investment's high yield, for example, you also need to consider the below factors:

• Financial strength - the key to paying the dividend
• Future growth - the key to raising it
• Debt/Leverage - the weight pulling down the company

Simon Property Group

Simon Property Group's Preferred REIT (see Figure 1) as listed in Charles Schwab will be used as a case for further illustration.

Terminology:

• Current Yield
• Current Yield = Indicated Annual Rate / Share Price as of previous close
• 5.80% = $4.19 / $72.25
• Stated Call
• A security with a stated call can be redeemed prior to maturity at the issuer's discretion on specified dates at specified prices. Callable securities are generally more risky for investors than non-callable securities because an investor is often faced with reinvesting proceeds at a lower, less attractive interest rate.
• Stated Call Values
• Yes: The security is callable, but a call notification has not been issued.
• No: The security is not callable.
• Call Scheduled: A call notification has been issued for this security.
• Cumulative
• A preferred security with a cumulative feature requires a company to make a dividend or interest distribution to shareholders of that security before any other distributions can be made to common shareholders. 
• When a company fails to make a dividend or interest payment to preferred shareholders, the past omitted payments accrue and are paid in a future payment to a cumulative preferred shareholder before distributions can be made to any common shareholders.
• Extraordinary Call
• Investments with extraordinary call provisions provide an issuer the right to redeem a security before the maturity date due to unforeseen or unusual circumstances. 
• Reasons an issuer might use an extraordinary call provision include asset sales, covenant violations, and tax law changes among other reasons. 
• The terms of the redemption are stipulated in the official statement for the security. 
• Securities with extraordinary call provisions require extra due diligence by investors. If you buy a security with an extraordinary call provision at a price above par value, and the security is called, you would generally receive par value, and forfeit any premium paid for the security.
• Sinking Fund
• An account to which the issuer must make periodic payments to be used to redeem specific outstanding securities. 
• A sinking fund may be required by the official statement to improve the likelihood of repayment. 
• If the issuer fails to make payments to the sinking fund, it can result in default.
• Convertible
• A convertible feature of a preferred security traditionally provides the right for the holder to exchange one type of security for another, such as the ability to convert a bond or preferred stock to the issuer’s common stock. 
• There are instances, however, when this feature is provided to the issuer of the security, such as a mandatory conversion at a future date.

Figure 2.  Dividend / Coupon Features of SPG Preferred REIT (accessed on 09/02/2019 at Charles Schwab)

References

1. What's a REIT?
2. Sell Your Bonds! Buy REIT Preferreds Instead
3. Guide to Equity REITs
4. Guide to Mortgage REITs
5. REITs Are Solid Investments, But They’re Looking Pricey (good)
6. AGNC Investment Corp.: Not Suitable For Retirement Accounts
• Companies with long histories of increasing their dividend every year are desirable, and companies that reduce or cut dividends are considered undesirable.
7. Your REITs Will Vanish
8. REITs Are A Buy: These Are The Ones Dividend Growth Investors Should Focus On
• If payout ratio is below 65%, I'm very happy. I like a lower ratio for two reasons, the first is dividend safety and the second is the outlook for distribution increase.
9. Your REIT Could Go Bankrupt (good)
10. Charles Schwab OnInvesting (Summer 2019)
11. What is happening now with private REITs is more important to markets than the FTX blow up. (must read)