REITs are basically mutual funds of real estate properties, and sometimes this can be a little confusing. When you own a stock mutual fund, you know its value stems from the constituent stock prices and by the dividends paid by the corporations. Both of these ultimately depend on the profitability of each corporation.
It’s not that different in a REIT. The ultimate value of REIT units traces back to the profitability of the properties in the REIT and of the REIT corporation itself. For many sectors, profitability is a function of rental income and capital gains on the sale of properties. In some sectors, revenues come from operations that relate to the underlying properties. For example, timberland REITs receive revenue flows from the sale of lumber and wood products. Each REIT sector has some unique twists when it comes to its revenues, its growth potential and its risks.
The following table summarizes the primary revenue sources for the major REIT sectors:
|REIT Sector||Source of Income|
|Timberland||Lumber and Wood Products|
Let’s take a closer look.
Sectors That Depend on Rental Income
The sectors in this section primarily depend on the rental income from leases on the properties in the portfolio. Secondary sources of REIT income include gains on the sales of properties and fees from managing properties owned by clients and joint ventures. Generally, rent-based sectors rise and fall on the strength of the economy.
Office REITs own and manage offices and lease space in office buildings to tenants. You’ll find office real estate everywhere, from urban downtowns to office parks. Some office REITs specialize in specific types of areas, such as the suburbs or the central business districts. Another type of specialization pertains to tenant types, such as technology firms or government agencies. Sector growth is supported by a strong economy, which boosts demand for office space that drives rents higher. Investors must guard against inflation that causes interest rates to rise and bond yields to compete with those from office REITs. This can put a lid on price appreciation of REIT units. High interest rates also make it harder for office REITs to raise additional capital to fuel growth. A recession usually hurts office REIT revenues, as demand and rental rates fall.
Retail REITs own, manage and lease out retail space. REITs might own regional malls, grocery-anchored shopping centers, strip malls, power centers,
These REITs own and manage multi-family residences, apartment buildings, single-family homes, student housing and master planned communities, among others. Revenues are almost entirely tied to rents and management fees. Residential REITs have a countercyclical aspect. During recessions and periods of high unemployment, many potential homeowners can’t qualify for mortgages and must rent instead. At the other end of the spectrum, during inflationary periods, high interest rates might discourage some renters from assuming mortgages. Geographic distribution is an important growth factor, as residential rents move higher when demand is robust relative to supply. This favors fast-growing municipalities.
Industrial REITs rent space in industrial facilities to tenants. They also earn revenue from managing these facilities. REIT categories include those for manufacturing plants, warehouses and distribution centers. Industrial facilities are often located in industrial areas (for heavy industries) and industrial parks (light industries). Many industrial properties are fairly insensitive to the economic cycle until it hits extremes. A shortage of nearby labor can hamper development of new facilities. The green movement has added upside potential to eco-friendly industrial facilities.
Health Care REITs
Health Care REITs own and manage a variety of medical and health-related properties, including hospitals, medical office building, senior living facilities, science/medical labs
These REITs own a variety of facilities that provide technical facilities, such as telecommunication towers. Infrastructure REITs collect rents from companies that lease space. In many cases, multiple lessees can occupy the same facility. Infrastructure REITs are sensitive to technological innovation, such as new wireless network architectures and increased use of data. Booming international demand for technical services fuels growth of these REITs across the globe.
Sectors That Depend on Operations
REITs in this group earn revenue from operations that involve specialized real estate.
Timberland REITs own land covered by forests and derive their income from the sale of lumber and wood products. The biggest timberland REITs are vertically integrated companies that manage forest land, harvest trees, sell lumber and produce wood and cellulose products, including wood siding, plywood,
Self-storage REITs own and operate storage facilities and earn revenues from rental charges paid by businesses and individuals. Revenues depend not only on the percentage of available space rented out by customers, but also the efficiency of operations, sale of packing materials, truck rentals, taxes, competition, and barriers to competition. Self-storage REITs often profit from negative events – job losses, deaths, divorces, etc, which prompts individuals to downsize and place some property in storage. The mortgage meltdown of 2008 saw many homeowners lose their properties, creating high demand for self-storage facilities.
These REITs own and operate hotels, motels, resorts and other forms of lodging. Revenues flow from guest billings. Lodging REITs serve a wide variety of guests, from long-term residents to vacationers to business travelers. Travel and tourism are tied to the economic cycle. Changes in consumer preferences can affect hotel brands, for better or worse. Long periods of strong economic growth encourage the
Data Center REITs
Data Center REITs earn revenues from providing data center space and services to businesses. These services include the reliable operation of information systems, scalable data storage, and safekeeping of data. It also includes telecommunication facilities for the transmission of data across networks. Some customers co-locate their own equipment within public data centers and pay the centers for the space and operation of the equipment. Data center REITs are vulnerable to technological improvements that reduce the space needed for data storage. However, this is more than balanced by the explosion of big data across the globe.