When people want to invest in real estate they usually secure a loan to purchase a property - either residential or commercial. But there are other more efficient and less costly ways to invest in the property sector.
There are many benefits to direct real estate investment and it is easy to see why buying to let is an attractive investment option. However, it is also easy to overlook the considerable costs you can incur, and the drain this type of investment has on your time. Downsides include a lack of diversification, lower liquidity, vacancies leading to loss of rental income, property taxes, insurance and maintenance costs.
This is part of the reason why real estate investment trusts (REITs) have become so popular. REITs offer many of the same benefits of direct property investment, but without the problems.
A REIT is basically a company that owns a portfolio of income-producing real estate that provides investors the chance to own valuable real estate for as little as the price of a share. Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a unit trust type of product that specialises in public property. Six monthly dividends will come from the rent collected on these properties, and the value of your REIT shares can increase over time - subject to a stable market - as profits grow, so you’ll also own an appreciating asset that grows in value much like a stock.
Benefits of owning shares in a REIT
But it is not just about returns. The benefits of owning shares in a REIT, compared to direct real estate investing, are plenty. The first is greater diversification: With a REIT, you’re buying a piece of a large real estate portfolio. In comparison, with the price of property and all the other associated costs of buying, diversification of any sort is exceptionally difficult and if you were to buy a property yourself, you’d typically only be able to finance a single property rather than many.
The second is more liquidity: Since REITs can be bought and sold like a stock, an investor has much more liquidity when compared to investing in a physical property. The third benefit is the fact that you don’t have to invest your time being a landlord: Instead, there is a professional management team that does it for the investors of a REIT.
The data is clear. REITs have been the best performing asset class in South Africa for the majority of the past 15 years. In the past 18 months returns have reduced due to a number of factors, resulting in a cheaper entry into listed property. Therefore, if you’re thinking about increasing your real estate exposure and want access to a diversified pool of liquid real estate assets that give you six monthly dividends as well as capital growth, then a REIT is probably the right investment for you.
Property investment comparisons at a glance:
Purchasing property is expensive. Buying property directly will usually mean an investment of well over a R1m up to several million rands just for one asset. The minimum investment in a SA REIT is one share. Depending on the SA REIT, this could then be below R10.
When buying to let, any borrowing is done in your personal capacity and this introduces the risk of default, being blacklisted and potentially losing more capital than you put in. When buying property stocks, the borrowing is done by the REITs themselves. Therefore, there is no debt in your personal capacity and thus no risk of default.
Increasing interest rates
A rise in interest rates will directly impact your borrowing rate, and as such your monthly re-payments. When investing in REITs, the interest rate needs to be addressed by the REIT and not by you. Many of the REITs are hedging or have already hedged a portion of their interest rate exposure to minimise their risk in an increasing interest rate environment.
When you own a property, you face the risk of your tenant leaving, cancelling or not paying. When any of these things occur, you lose rental income and need to spend valuable time and resources finding a new tenant, tenant fit-outs etc. Of course REITs also have vacancy risks, and these cannot be avoided, however REITs have professional management companies in place to avoid vacancies, and vacancies are spread over a larger portfolio, reducing your income risk.
Rental income versus REIT distributions
Both rental income and distributions from REITs are not guaranteed. REITs obtain their rentals from a diversified portfolio, reducing the risk of zero distributions.
If you buy real estate yourself, you will typically only be able to afford a single property. REITs provide immediate diversification across a number of geographical locations (including offshore) and property types - including industrial, warehousing, offices, shopping centres and many more.
Rental properties are not liquid and it can take months or even years to sell a rental property. REITs are liquid investments that can be easily converted to cash timeously and without paying excessive fees.