A Real Estate Investment Trust (REIT) is an investment vehicle in which resources are pulled from small and large-scale investors and consequently invested in the real estate sector. The REIT is then traded on an open market exchange. The attractiveness of REITs to investors is because of the special tax incentives and high dividends that they usually receive.
The basic structure of a REIT is that it must at least have 75% of its assets in the real estate sector and must not have less than one hundred investors at any period. REITs are legally mandated to remit at least 90% of their income as dividends to their investors though majorities of them have dividend reinvestment schemes with their investors (National Association of Real Estate Investment Trusts, 2016).
There are three main classes of REITs. Equity REITs invest and own property and can be classified as either development or investment REITs. The former represents a situation in which a REIT pools funds to develop new properties from the ground up. On the other hand, investment REITs buy into complete properties. The second class of REITs is the mortgage REITs that operate by lending cash for mortgages to real estate owners. The hybrid REIT is the third class of REITs and it involves investors buying shares on the open market exchange or through a mutual fund that specializes in the real estate sector.
The Vanguard REIT index fund is a hybrid REIT that invests in a well-diversified portfolio ranging from healthcare to hotel and resorts among other subsectors. The fund as at the end of the first quarter (Q1) of 2016 held $57.3 billion in total net assets spread across one hundred and fifty real estate entities (Vanguard, 2016). The total net assets of the ten largest holding s represent 36.5% of its overall assets. As of 31st March 2016, its largest holding was that of the Simon Property Group Inc. with a weighting of 8.2%. Closing the top ten largest holdings list General Growth Properties Inc. (Vanguard, 2016). A look at the holdings by the sub-sectors indicates that retail REIT has the largest weight at 25.1% followed by residential at 16.8% and office REIT at 16.3%.
Prior to the 2007/2008 financial crisis, the Vanguard REIT index fund performed relatively well. It came against the backdrop of consistent performance that yielded annual returns at an average rate of 10.76%. Its strong financial performance at the time is evidenced by the high relative price that its index fund commanded at the exchange. Its price-weighted index as of 2006 was 35.19. Its real estate price index stood at 36.26 while its net asset value was calculated to be 33.87 (Morning star, 2016). Its net expense ratio for the year was zero, a pointer to its efficient management and subsequent strong financial performance.
The 2007/2008 financial crisis hit the real estate sector the hardest. It is the case that it had its origins in the sub-prime mortgage crisis. It was therefore expected that the performance of the Vanguard REIT index fund would be severely impacted. It is against the backdrop of studies that have shown there is a positive co-relation between the performance of the economy and the real estate sector with the latter being pro-cyclical, which ultimately has a bearing on the performance REITs.
The weighted price of the Vanguard REIT index fund fell drastically over the two years of 2007 and 2008 trading at -16.40 and -36.94 respectively on the exchange. However, with the economy showing some signs of resurgence, the REIT equity fund has recorded some significant gains that have ensured its strong financial performance over the period to date. In 2009, the Vanguard REIT index recorded a weighted price of 30.08; a remarkable resurgence from its all-time low of 2008 (Morning star, 2016). In 2009, the net expense ratio stood at 0.11. Its yield to maturity (YTD) for the ten-year period covering before, during, and after the 2007/2008 financial crisis (2006-2015) is 3.79. However taking into consideration only the post-financial crisis period the yield to maturity rises to 4.16%. This remarkable performance has continued to attract investors to the fund making it one of the largest REITs in the country.
Going forward, the future of REITs as a tool in real estate finance appears bright. It is because of the realization that it offers a means of investment diversification. It is especially the case considering that it takes on a divergent path from the traditional investment tools. Despite the difficult period REITs underwent following the 2007/2008 financial crisis, they have performed relatively better when compared to other investment instruments. There have been arguments that the anticipated progressive increases in the federal rate reserve would push bond yields higher, which would then dampen the outlook on REITs. However, rising interest rates certainly signify an improvement in the economy, which also portends well for the real estate sector, which would ultimately raise the demand for REITs. However, in the event that the economy does not perform as expected, REITs remain a safe fall back plan.
Ultimately, it is the inherent nature of REITs in allowing for both small and large scale investors, that will continue to endear it to many as the preferred tool in the real estate sector. With an improving economy, more people would want to be part of the anticipated boom in the real estate industry especially the small-scale investors leading to an uptake of REITs.
References
Friedrich, M. (2009). REITs and the Financial Crisis: Empirical Evidence from the U.S. International Journal of Business and Management , 4(11) , 3-8. Retrieved May 11, 2016 from http://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/3308/3593
Morning star (2016). Vanguard REIT Index Fund ETF Shares. Morningstar.com Retrieved May 11, 2016 from http://performance.morningstar.com/funds/etf/total-returns.action?t=VNQ
National Association of Real Estate Investment Trusts (2016). NAREIT Developments Blog. Reit.com Retrieved May 11, 2016 from https://www.reit.com/nareit
Vanguard (2016). Vanguard REIT Index Fund Investor Shares. Vanguard.com Retrieved May 11, 2016 from https://personal.vanguard.com/us/funds/snapshot?FundId=0123&FundIntExt=INT
