Understanding the benefits of REITs in the US market
The FTSE NAREIT US Real Estate Index Series
Real Estate Investment Trusts (REITs) have enabled investors of all types to gain access to a regular income stream, a diversified portfolio of underlying properties and a link to the capital values of the portfolio holdings by means of companies with securities listed on a public stock exchange.
The FTSE NAREIT US Real Estate Index Series is designed to represent the performance of qualifying REITs listed on the New York Stock Exchange (NYSE) or NASDAQ.
FTSE launched the index series in 2006 in partnership with the National Association of Real Estate Investment Trusts (NAREIT®). NAREIT is the US-based association for REITs and publicly traded real estate companies.
What are REITs?
A REIT is a company that owns or finances income-producing real estate. Unlike real estate companies that focus on developing properties in order to resell them, REITs buy and develop properties primarily with a view to holding them within their own investment portfolios. REITs thereby aim to provide investors with a regular income stream, a diversified portfolio of underlying properties and a link to the capital values of the portfolio holdings. A REIT’s shareholders thus earn a share of the income produced through real estate investment, without actually having to go out and buy or finance property.
The US REIT market dates from 1960, when Congress passed the REIT Act to make real estate investment available to all investors and to encourage the development of a broader investor base for commercial properties.
Under US law, to qualify as a REIT a company has to invest at least 75 percent of its total assets in real estate and derive at least 75 percent of its gross income from rents from real property, interest from mortgages secured by real property or from sales of real estate. US law also requires REITs to distribute each year at least 90 percent of their taxable income to shareholders, who then pay income tax on the dividends they receive. REITs are allowed to deduct dividend payments from their taxable income.
REIT or “REIT-like” legislation now exists in 36 countries around the world, covering the majority of the major developed investment markets. In the US market, REITs fall into three principal categories:
- Stock exchange-listed REITs are registered with the SEC and their shares are listed and traded on public stock exchanges and face the financial disclosure and corporate governance obligations required under US law for public companies.
- Public, non-listed REITs are registered with the SEC but their shares are not listed or traded on stock exchanges and investors may face restrictions on their redemption rights, such as a minimum holding period, often a number of years.
- Private REITs are not registered with the SEC, do not have their securities listed and are therefore not subject to disclosure or corporate governance requirements of the SEC or any stock exchange, while investors’ redemption rights vary from REIT to REIT.
The FTSE NAREIT US Real Estate Index Series focuses on listed REITs, which had a total equity market capitalization of $1 trillion, as of September 30, 2016. Via their stock exchange listings, REITs offer their investors a way of reducing the risk of illiquidity that has traditionally been associated with direct investments in real estate. According to NAREIT, daily average dollar trading volume in REITs rose from about $100 million in 1994 to $7.1 billion in July 2016.
Types of REITs
REITs fall into one of two categories: equity and mortgage.
Equity REITs own and operate commercial and residential properties. Mortgage REITs provide financing for real estate through investments in mortgages and mortgage-backed securities. They may originate commercial mortgage loans, securitize mortgage loans and engage in other activities that support the financing of commercial real estate. Equity REITs thereby offer investors the opportunity to gain exposure to the returns available from equity ownership of real estate, while mortgage REITs offer the opportunity to gain exposure to the returns from the debt financing of real estate.
The FTSE NAREIT US Real Estate Index Series includes both composite indexes (covering all REITs) and sub-indexes for equity and mortgage REITs.
According to NAREIT, equity REITs represented 95% of the US REIT market by value in September 2016, with mortgage REITs constituting the remaining 5% of the REIT market’s overall capitalization.
Equity REITs own and manage properties in a variety of economic sectors, including malls and shopping centers, apartments, health care facilities, data centers, hotels, offices, industrial premises, telecommunication towers and others. Most REITs, however, tend to specialize in one property type only.
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