It's not just one of the oldest forms of investment, it's one of the most important. Real estate markets involve much more than buying residential homes and commercial buildings, so this post will discuss three significant forms of real estate investment: Real Estate Investment Trusts (REITs), Real Estate Funds (REF), and Real Estate Operating Companies (REOC) such as Mainstreet.
Real Estate Investment Trusts (REIT)
REITs did not officially exist in Canada before 1995, the model up to that point was simply "open-ended mutual funds which held interest in real property." It was the need within the real estate sector to develop new strategies of capitalizing on value which led to their creation under Canadian law: "The advent of REITs has allowed for the securitization of investment-grade real property that would be otherwise illiquid." In other words, creating REITS allowed real property owners to securitize that property, meaning it allowed them to use that property to raise money for operating expenses and capital expenditures where they had previously been unable. The best way to understand this difference is that a REIT essentially allows you to own part of a property, but that property may be any one of a wide range of property types across a variety of locations throughout both the country and the world.
Canadian REITs by Sector (Source: DividendEarner)
Despite these advantages, though, it is important to recognize the drawbacks as well. REITs usually assume the form of publicly traded shares in a company specializing in acquisition, ownership, improvement/maintenance, and management of properties. Unlike corporations such as Mainstreet, which use cash flow to grow the company and improve and maintain its portfolio, REIT income generated through rent or leasing become dividends, and equity is frequently diluted with growth. REITs borrow the most money possible from lenders at the lowest rate of interest possible to generate their best returns. Unfortunately, this leaves REITs vulnerable to economic downturn or industrial shifts which increase vacancy as well as even small interest rate hikes, both of which have finished off some REITs.
Real Estate Funds (REFs)
Real estate funds also present unique risks, including liquidity risk, market risk, and interest rate risk, whose gains or losses are all passed onto the investor. Growth-oriented funds assume most of the liquidity and market risk, while income-oriented funds assume most of the interest rate risk. Even before these risks are considered, however, it is important to remember that "...even though they are popular, real estate funds remain complex investment vehicles which carry significant legal risks in their formation and operations. As a result, experienced counsel should be sought out when forming or investing in a new fund."
Real Estate Operating Company
Real Estate Operating Companies are most often safer for investors than their private counterparts. Further, they may represent the best option for those looking to invest in a growing operation, as these investments are generally both more accessible and transparent. If the business model makes sense and their growth aligns with your desired returns, this may be the safest bet. It's important to recognize that unlike REITs, well-run REOCs will often drive value by reinvesting cash flow in capital expenditures and acquisitions, sustaining their growth organically. Conversely, REITs divert income to dividend payments and can generally only raise capital by issuing new shares and diluting current shareholder's equity.
Publicly Traded REOC (Mainstreet) Compared Against Typical REIT