Boring Terms We Need To Know: REIT

Wouldn't it be nice to own real estate and collect regular payments from renters while the property you own continues to increase in value?  Of course  you typically have to have a lot of money (or debt) to own these rental properties.  You also have to have the knowledge of what properties would make good investments vs what would be a money trap.  Being a landlord is certainly appealing, but I don't have the capital or in-depth real estate knowledge needed to be successful.  That's why I like Real Estate Investment Trusts (REITs).

REITs are corporations that primarily own and usually operate real estate that generates revenue.  These properties can include hotels, commercial office buildings, rental homes, apartment complexes, etc…  The great thing about REITs is that they are required to pay 90% of their annual taxable income to its investors in the form of dividends.  By doing this the corporation reduces or eliminates having to pay taxes.  As you can imagine, paying out 90% of a company's income can lead to large dividend payments and yields.

There are two main types of REITs:

Equity REITs own and operate revenue generating real estate. Properties are purchased or developed to operate and keep in portfolio, not for resale. They are held as long term investments and their revenues come principally from their properties' rents.  Equity REITs are the most common REITs.  These stocks can provide a high initial dividend yield and steady, consistent increases in dividend payments through property growth and rent increases.  Some popular equity REITs are:

• Realty Income (O)  You may remember my fun example explaining the power of compounding using O.  Realty Income owns well over 2000 retail properties and has 18 years of dividend growth.
• National Retail Properties (NNN) is an equity real estate investment trust that invests in high-quality, freestanding retail properties subject to long-term net leases with major retail tenants.  NNN has over 20 years of dividend growth.
• HCP Inc (HCP) is an equity-oriented real estate investment trust, based in California, that has direct or joint venture investments in health care-related facilities across the U.S.  HCP has over 11 years of dividend growth.

Mortgage REITs lend money to real estate owners or extend their credit by purchasing loans or mortgage-back securities. They generate revenue based upon the interest in mortgage loans.  When interest rates are low mortgage REITs can have large dividend payments that exceed double-digit yields which can be used for income, but these are typically not good long-term dividend growth investments. Some popular mortgage REITs are:

• Annaly Capital Management (NLY) invests primarily in mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, and other mortgage-backed securities.
• Hatteras Financial Corp (HTS) invests in fixed-rate and adjustable-rate single-family residential mortgage pass-through securities guaranteed or issued by the United States Government agency or by the United States Government-sponsored entity, and the Federal Home Loan Mortgage Corporation.

When evaluating REITs there are key financial terms that are more important than the usual statistics we are familiar with.  Instead of net income, we care about funds from operations (FFO).  In general, the adjustments FFO makes to net income are intended to compensate for accounting methods that may distort a real estate investment trust's true performance.  Net asset value (NAV) reflects the market values of real estate properties held by an investment corporation.  Cash (or Funds) available for distribution (CAD or FAD) is a measure of a REIT's ability to generate cash and to distribute dividends to its shareholders.

We can get into those in greater detail later.  I hope to have a REIT-specific stock dividend analysis system in the future that takes the above into consideration.

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