A real estate investment trust (REIT) is a company that finances, operates or owns real estate that produces an income, and is a way for investors to have a liquid stake in the real estate market.
According to Nareit, which is the representative voice for REITs, more than 225 REITs were trading on an American stock exchange earlier this year. At the start of 2018, a quick look at diversified REITs suggested that 23 were yielding 5% or more, with market capitalisations of greater than US$1 billion. And that was only when reviewing one sub-sector of the industry — if you took into consideration other areas, such as retail and office, the number increased to 60 REITs.
Given the vast array of REITs available, it can be hard for investors to know which one to choose. However, while the attraction to REITs can be strong — especially as they are required by law to distribute at least 90% of their annual taxable income to shareholders — not every REIT is worth its salt. Even if one has a dividend yield of 5%+, it doesn’t necessarily mean you should want to own it.
To hedge or not to hedge?
Cross-border real estate investment is becoming more popular as more people develop their understanding of the role that real estate can play in a multi-asset class portfolio. Many investors have also become aware of the potential diversification benefits that can be gained from international real estate exposure.
However, it’s important to appreciate the complexity that currency can bring to the table when it comes to investing in property. Returns can be hugely impacted by currency movements, and performance can look very different when measured in different currencies. For example, over the course of 17 years, one global property index’s annualised total return was 7.4% in its local currency, but if measured in South African Rand, the total return would have been 11.2%, and in Swiss Francs, it would only have been 4.9%.
If you do have a foreign currency exposure, it is, therefore, important to carefully consider how you intend to manage your exposure. Certain risks can potentially be mitigated through currency hedging. According to an article published by the Pension Real Estate Association (PREA) “forwards, swaps, and options are some of the commonly used instruments for hedging currency risk in a real estate portfolio. Some investors may also borrow in foreign capital markets to reduce their foreign exchange exposure. However, the latter approach may simply substitute financial risk for currency risk, and the cost of borrowing offshore may be higher. Certain large global investors may also see their portfolios as sufficiently diversified to provide a natural hedge and not actively hedge at all.”
You may also wish to consider other factors, such as when is the right time to hedge and what should be hedged. And it’s also worth considering the cost and regulatory hurdles when it comes to managing currency risk. Many decisions are not always straightforward, but it’s important to be aware that currency volatility could become a source of investment risk as real estate becomes more global in nature.
Although many investors appreciate the unique nature of REITs, it’s important to only invest in REITs that you’ve thoroughly researched. In order to protect your principal, try to find a REIT that comes at a price that allows for a safety margin against market risk. It’s also advisable to not consider a REIT that could potentially cut its dividend, and be sure to pay attention to underlying cash flows.
If you’re interested in REITs that can serve you in good times and bad, you may wish to look for stocks that provide an income while minimising risk — for example, stable business operations that have good balance sheets. Although the yields from certain REITs may not make you super rich, they can still reliably contribute to your financial goals and wealth portfolio. Don’t hesitate to arrange a meeting if you wish to discuss the value of real estate as an income-generating investment and how to best manage your cash flow.
(Information gathered from Forbes and InvestorPlace)
