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Luxury REIT: A good investment option or a gamble?

A real estate investment trust (REIT) is a company that owns and operates income-producing real estate. Just like mutual funds, they collect investors’ funds to make investments in real estate and then distribute the profits as dividends. 

How do they work?

Traditionally, investing in real estate is capital intensive. A solo investor would either have to buy or build, both of which may cost a fortune. Not to talk of all the technical knowledge he would require or have to pay for. The United States’ Congress established REITs in 1960, under President Eisenhower, to offer less wealthy people access to investing in the real estate market.

Properties in a luxury REIT might include high-end office buildings, luxury apartment buildings, upscale hotels, and resorts. However, most REITs usually restrict their investments to one sector. For example, PropertyClub NYC manages and rents out luxury apartments in New York City. REITs sell shares of these portfolios to their investors, who then receive dividends on profits made.

There are three major types of REITs

  1. Publicly traded REITs. Publicly traded REITs are registered with the SEC, and their shares are traded openly in the securities market. 
  2. Public non-traded REITs. Non-traded public REITs are registered with the SEC also. However, their shares are not listed in the securities market.
  3. Private REITs. Private REITs are neither registered with the SEC or listed on the securities market. Their shares are sold to exclusive investors through specialized brokers.

Pros of investing in luxury REITs

  1. Liquidity. Unlike traditional real estate investments where you have to go through multiple processes to buy or sell property, REITs are much more liquid. You can buy and sell shares almost immediately.
  2. Regular cash flow. Luxury REITs promise regular cash flow in the form of dividends. Also, not many investments can pay you dividends as high as you would get from investing in REITs.
  3. Potential long-term capital growth. While capital growth in luxury REITs is slow, it is not non-existent. Over the last two decades, the REIT industry has surpassed the S&P 500 Index and has risen in the face of inflation.
  4. Diversification. What better way to diversify your portfolio than to invest in real estate? Investing in luxury REITs provides a safe and cost-effective pathway to do that.

Cons of investing in luxury REITs

  1. Slow capital growth. REITs are required to pay 90% of their revenue to the shareholders as dividends. Thus, only 10% of revenue can be plowed back towards acquiring more property. Hence, capital growth is very slow.
  2. Taxes. Unlike mutual funds that can be tax-exempt, all REIT dividends are taxed as regular income. 
  3. Fees. There is also the problem of high management fees. Investment funds always charge fees for managing your portfolio, they also charge transaction fees. These fees can shave a sizable chunk off dividends.
  4. Market risks. REITs are susceptible to market risks. A sharp rise in interest rates is bound to reduce REIT share prices. 

luxury reit

Is investing in a luxury REIT a great choice or a gamble?

Now that you have basic knowledge about REITs and how they work, we can tell you whether or not REITs are a great investment choice.

First of all, just like every other investment vehicle, it is all up to you. REITs are suitable for people who want the security of stable income. For example, there are older people, trying to reduce their exposure to risks. And for some younger investors who might be more willing to undertake risky projects, luxury REITs can still serve as security. Plus, they are liquid and can be quickly converted into quick cash.

A gamble is a game of chance, with 50/50 outcomes. REITs are the exact opposite. With the annual payment of dividends, you can’t lose. It is even more profitable in New York, where too many people seek to rent too few apartments. Thanks to the influx of young, high earning tech workers, more people than ever are seeking to rent luxury apartments. Investing in a Luxury REIT company based in NYC is bound to yield significant dividends.

Points to consider before choosing a REIT

Before you choose a REIT to invest your money in, there are a couple of points you have to consider.

      Ensure that the REIT satisfies the requirements of the law.

  • According to the internal revenue code, a REIT must hold 75% of its total assets in real estate, cash or treasury bills.
  • At least 75% of the trust’s total revenue must come from the rent, interest on mortgages, or real estate sales.
  • At least 90% of taxable income must be paid to investors.
  • Every REIT must have at least 100 shareholders after one year of operation.
  • No more than half of all the shares can be held by five or fewer individuals.
  1. You should check the SEC’s EDGAR system to be sure the REIT is properly registered. It doesn’t matter whether it is publicly traded or not.
  2. Also, check that the investment advisor you are consulting is properly licensed. Again, the SEC has a system for checking that.
  3. Like we have said earlier, most REITs are industry-specific. Before you commit to a REIT, you have to independently gauge the health of the sector it is focused on. This will help you make the most of your investment.
  4. You have to look at the numbers. Before you commit to a REIT, analyze its anticipated growth in earnings per share and current dividend yields. Observe the REIT’s funds from operations (FFO), which is calculated by adding depreciation and amortization to earnings and then subtracting any gains on sales. You can also use SEC’s EDGAR to review their annual and quarterly reports. Also, compare management and transaction fees. You don’t want to commit to a REIT that shaves off a sizable chunk of your dividend with fees.
  5. Lastly, seek information on its modalities for executive compensation.  A management team that is compensated based on its performance will be more motivated.

Finally, it is a good point to mention that whatever option you decide to go with, chances are that you are going to sign a contract of some sort. If this is the case, it is a good idea to be absolutely sure you understand all the terms stated in the document or contract. Ensuring that a good real estate attorney looks through the document you will sign will more than likely be in your best interest.

Author Bio: Kanayo Okwuraiwe is the founder of Telligent Marketing LLC, a digital marketing agency that provides local SEO for lawyers to help them grow their law practices. Connect with him on Linkedln.

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