A real estate investment trust (REIT) is a platform that allows investors to make securitised real estate investments in small amounts. It works much like a mutual fund, pooling funds from various investors into one basket.
Real estate is a physical asset. Through REITs this asset is broken into several parts and converted into a paper investment, or securitised. REITs help make investments in real estate more accessible, long-term and income oriented.
They also help to build an efficient secondary market for developers to exit the projects. REITs usually invest in commercial properties and use the rental income to give dividends to unit holders. REITs mostly invest in completed properties to get a stable income stream. They tend to bypass under-construction properties .
Globally, there are two major kinds of REITs: equity and mortgage.
These own or develop and hold the properties, either individually or through special purpose vehicles (SPVs). Hence, they are referred to as equity REITs. Their income is in the form of rent received from leasing the property. This rent gets transferred to unit holders as dividend.
These operate mainly by lending money to property owners—in exchange for a mortgage claim on the property, or through mortgage-backed securities. Their earnings come from the interest charged on such loans.
Hybrid REITs are a combination of equity and mortgage.
The advantage of REITs is that you don’t need a large sum to profit from real estate. REITs are regulated and managed as a trust, which means there is accountability and audit of how investor funds are used. Real estate is often considered an unorganised sector and there can be ambiguity in transaction values.
With REITs, the transactions are monitored and there is a specified method of valuation, so ambiguity is reduced