How REITs Operate

Because REITs are required to distribute 90 percent of their taxable income to investors, they must rely upon external funding as their key source of capital. Just like other stock offerings, publicly traded REITs collect funds via an initial public offering (IPO). Those funds are used to buy, develop and manage real estate assets. The IPO works just like other security offerings except that instead of purchasing stock in a single company, the buyer will own a portion of a managed pool of real estate. Income is generated through renting, leasing, or selling the properties and is distributed directly to the REIT holder on a regular basis. When a REIT pays out its dividends, they're equally distributed among shareholders as a percentage of paid-out taxable income.
REITs have a board of directors elected by its shareholders. Typically, these directors are real estate professionals who are highly respected in the field. They are responsible for selecting the REIT's investments and hiring the management team, which then handles day-to-day operations.
REITs earn money from rented space or sales of property. The preferred method for measuring REIT earnings is called funds from operations (FFO). The National Association of Real Estate Investment Trusts (NAREIT) defines FFO as:

Net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.

Basically, REITs add or deduct from net income (rent and sales computed according to generally accepted accounting principles [GAAP]) any gains or losses due to depreciation, sale of property and unconsolidated partnerships and joint ventures. Essentially, FFO measures a REIT's operating cash flow produced by its properties, less administrative and financing costs.
Under generally accepted accounting principles, net income typically assumes that the value of assets goes down over time -- somewhat predictably. Real estate generally retains or even increases in value. On the balance sheet under GAAP, however, land remains at its historical cost and buildings gradually depreciate to zero. Since a REIT's primary business involves real estate, the depreciation charges negatively skewed the company's true profitability. FFO was adopted to address that problem by excluding depreciation costs from the net income figure.
FFO is not a foolproof measure, however. Not all REITs calculate it according to the NAREIT definition and items such as maintenance, repairs and other recurring capital expenses are missing from the formula. In order to get a true FFO, investors must often read a company's quarterly report, and any supplemental disclosures.

Avraham
martinezglobal@gmail.com

Real Estate Prices versus REIT Prices

I talked about my experiences with the rental properties that my wife and I own recently.   For the first and second rentals we've seen about 7% annual appreciation and 5-8% return on equity.   Thats a pretty good investment.   But then I wondered  "hmmm.. what if I'd just bought a REIT instead?".   Might I have also seen 7% appreciation and a 5-8% return via dividends?   Possibly.   That line of thinking brought me to the general question :  How do REIT prices correlate to real estate prices in general?   I'd assume that the market price of REITs will go up and down roughly equal to the increase or decrease in real estate values in general.   Seems like common sense, so this should be an exercise of proving the obvious.


To test this I decided to compare a REIT index fund to a general real estate price index.   For REIT prices I chose to look at the Vanguard REIT index (VGSIX).    For direct real estate values I used the data from the S&P Case-Shiller index off the S&P site.   I then normalized both indexes to 100 starting in 1996 and plotted both up until most recent data for Nov. 2009.


Below is a graph showing the price of VGSIX versus the Case-Shiller index:  

You can see that the correlation between the two is pretty strong.  However the REIT index prices are a bit more volatile.  That should be expected since the market can easily react and dump a very liquid REIT but actual physical property is much less liquid.    If you exclude the last 13 months post Oct. 2008 then the trends of both are very similar.   In the fall of 2008 the values of REITs dived drastically as a reaction to the real estate bust and credit crisis.




The performance of REITS has been worse in this arbitrary snap shot mainly because of how badly REITs were battered during the recent recession.    I could break down the numbers a lot more but I don't want to read a whole lot into this.  The point was to see if theres a close relationship between REITs prices and real estate prices and I think the graphic shows that to be true in a general sense.


REIT prices and real estate values are close in performance but REITs are more volatile.


A.Martinez
martinezglobal@gmail.com

What Is Investing?

It's actually pretty simple: investing means putting your money to work for you. Essentially, it's a different way to think about how to make money. Growing up, most of us were taught that you can earn an income only by getting a job and working. And that's exactly what most of us do. There's one big problem with this: if you want more money, you have to work more hours. However, there is a limit to how many hours a day we can work, not to mention the fact that having a bunch of money is no fun if we don't have the leisure time to enjoy it

You can't create a duplicate of yourself to increase your working time, so instead, you need to send an extension of yourself - your money - to work. That way, while you are putting in hours for your employer, or even mowing your lawn, sleeping, reading the paper or socializing with friends, you can also be earning money elsewhere. Quite simply, making your money work for you maximizes your earning potential whether or not you receive a raise, decide to work overtime or look for a higher-paying job.

There are many different ways you can go about making an investment. This includes putting money into stocks, bonds, mutual funds, or real estate (among many other things), or starting your own business. Sometimes people refer to these options as "investment vehicles," which is just another way of saying "a way to invest." Each of these vehicles has positives and negatives, which we'll discuss in a later section of this tutorial. The point is that it doesn't matter which method you choose for investing your money, the goal is always to put your money to work so it earns you an additional profit. Even though this is a simple idea, it's the most important concept for you to understand. 

Avraham
martinezglobal@gmail.com