Most investors are familiar with REITs, or real estate investment trusts. Originally started in the U.S., the idea of giving investors a way to invest in high-value real estate, in the same way they do into other types of assets, proved popular in a number of other national economies. REITs are now available in over 20 countries and counting.
The basic appeal of REITs is that they are required by law to distribute all or the vast majority (90% in the U.S., 100% in Canada) of their taxable income to their shareholders. This makes them exempt from most corporate taxes, which means they can offer investors higher yields versus regular real estate investments.
Investors can either invest in REITs by buying shares on the stock market or by investing in mutual funds that specialize in REITs or otherwise include REITs in their portfolio.
REITs themselves can specialize in the type of real estate investments they can make:
- Equity REITs: Equity REITs generally invest in and hold real estate portfolios so that most of their revenue comes from the income generated from the property through rents and leases.
- Mortgage REITs: Mortgage REITs buy, sell and hold real estate mortgages. Generally, Mortgage REITs will either loan money for investment in real estate or buy existing mortgages, which means their returns are dependent on the interst earned ffrom their investments.
- Hybrid REITs: Hybrid REITs invest in properties and mortgages so their revenue streams are more diverse.
REITs invest in a variety of high value real estate, including shopping centres, commercial real estate, industrial real estate and hotels. Many REITs specialize their investments, either in one particular type of real estate, like office buildings, or on particular geographic locations. Some have been set up by corporations that have large real estate holdings to manage the company’s portfolio and generate revenue from a static portfolio.
Most investors are not as familiar with REOCs, or real estate operating companies. Sinilar to REITs, REOCs are publicly-traded companies that acquire, develop, manage and/or operate real estate properties. REITs are attractive because they avoid taxation by distributing all of their revenue to shareholders. REOCs instead reinvest their earnings into the organization and assets. This keeps REOcs financially strong and self-financing.
While REOCs don’t enjoy the same tax advantages as REITs, they are attractive investments for other reasons. REOC investors enjoy relatively high returns on capital, returns on equity, return on assets and potential share re-purchases. In other words, instead of getting regular dividends as they would from REITs, REOC investors look for capital gains from high returns ion their investment.
Why is it So Important to Understand the Difference Between REITs & REOCs Right Now?
Interest rates have been at historic lows for many years. The resulting effect on treal estate markets have made REITs very attractive investments.
But where there is demand, there is usually over valuation and many REITs sport high P/E Ratios.
Conversely, being overlooked in the real estate stampede has resulted in many REOCs being under-valued, which makes them very attractive investments.