Market Outlook 2023: Navigating Economic Uncertainty

Market Outlook 2023: Navigating Uncertainty in Geopolitical and Macro-Economic Headwinds

As we enter 2023, the market outlook is facing a multitude of uncertainties as the geopolitical and macroeconomic headwinds that plagued us in 2022 still persist. The global economy did not see the strength that many had hoped for, as unprecedented inflation swept through economies not seen in almost two generations.

The Fed and other central banks tightened monetary policy, widening credit spreads, and causing sell-offs across equity markets. Political strife in several areas across the globe did not help the situation either, and to top it off, we saw the biggest war in Europe since World War II with the Russian invasion of Ukraine.

Where are the markets now, and what can we expect for the future? While we cannot predict the future, it is reasonable to anticipate that many of the challenges we faced last year will continue to affect the market outlook for the foreseeable future. The Ukraine War, in particular, will likely have a significant impact on investor confidence as it continues to unfold. The direction of domestic and global inflation is another area of uncertainty.

While U.S. inflation seems to be slowing down, history has shown that we could still be returning to an accelerating pace of rising prices. This makes it difficult to predict how inflation will affect economic growth in a monetary tightening environment. Therefore, we should expect continued turbulence across asset classes, strategies, and markets.

Despite the challenges, there were some managers and strategies that successfully navigated the 2022 environment and generated strong returns for investors. These include global macro, equity market neutral, multi-strategy on the hedge fund side, and private credit, LBO, and some venture on the private markets side. These managers and strategies may be well-positioned to capitalize on global uncertainty if these trends continue in 2023.

As we face more uncertainties from a political, social, and economic point of view, this may be the start of a golden age for alternative assets. Alternative assets may provide a way for investors to diversify their portfolios and potentially generate strong returns in the face of continued market volatility.

2022 Year in Review

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To better understand the market outlook for 2023, we must first reflect on what happened in 2022. While there was a lot of volatility in prices, the year started and ended with almost identical rates of inflation (7.04% on Dec 31, 2021; and 7.11% on Nov 30, 2022). Despite this consistency, inflation had a significant impact on the markets, with low growth and rising rates causing credit spreads to widen and equities to sell off.

Alternative Assets Outperformed in 2022 Amidst Volatility and Uncertainty

In the world of finance, the year 2022 was marked by an unprecedented degree of volatility and uncertainty. As the Federal Reserve started to tighten monetary policy, raising the Federal Funds rate by 75 bps at its July meeting, the immediate impact on growth was apparent, with two quarters of contraction in the middle of the year and a significant slowdown in employment.

Meanwhile, consumer confidence and spending, as well as the housing market, remained robust, while business confidence, as measured by the ISM Purchasing Managers Index, only recently turned negative in Nov of 2022.

In public asset markets, nearly all USD-denominated risk assets experienced a year-over-year selloff, including the S&P 500, Dow Jones Industrial Average, U.S. Treasuries, Barclays AGG, and cryptocurrencies, as well as some energy, agricultural, and industrial commodities prices. As a recent article in Vox put it, "the economy just doesn't make sense anymore."

However, despite this backdrop of turbulence, some alternative assets saw strong performance throughout 2022. Hedge funds, in particular, outperformed the S&P and AGG in 2022, with nearly every HFRI index delivering positive returns. Strategies that traditionally capitalize on high volatility and market uncertainty, such as Global Macro, saw particularly strong returns, with the HFRI Total Macro Index returning +9% over the last year, and the HFRI Equity Market Neutral Index seeing returns of nearly 2%.

On the private market side, while overall performance with private equity remained muted, private credit experienced enormous growth, driven by a handful of factors. As rates rose and risk appetite dropped, the primary market for syndicated and leveraged loans nearly evaporated, with a transition from banks being the primary source of funding to the direct lender ecosystem within private credit.

At the same time, investors' allocations to private credit have gone to a smaller pool of funds, as the private credit markets have started to mature, with investors finding themselves more selective when choosing a manager as the importance of diversification, track record, experience, and independent service providers rises to the forefront of investors' minds as recession fears loom.

Market Outlook for 2023: Insights for Investors

As the world enters 2023, uncertainty looms over the global economy. While it is challenging to predict the market outlook for this year, the events of 2022 offer insights into the factors that could affect the markets. In this article, we will look at some of the key issues that investors should consider before making investment decisions.

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Geopolitical Front: Tensions in Key Regions

Geopolitical factors such as war, civil unrest, and political tensions are likely to continue to affect markets in 2023. The ongoing war in Ukraine and tensions in the Taiwan Strait and the South China Sea may have a significant impact on the public’s perception of the global economy. Additionally, the sociopolitical unrest that Iran experienced in the last several months may escalate, further affecting the markets.

The Impact of COVID-19

COVID-19 remains a critical factor affecting the global economy, and it is likely to continue to do so in 2023. As China shifts from its zero-COVID approach to a more open economy, we can expect some degree of social strife as society adjusts.

The resurgence in purchasing power experienced by China after the initial lull from COVID-19 in late 2020 could lead to supply chain bottlenecks that could spill over to other parts of the world. At the same time, the recent rise in cases and deaths in China could result in a reactionary shutdown, affecting its economy and industrial capacity.

Macro-economic Front: Inflation and GDP

Forecasting how inflation and GDP will perform is challenging. However, investors and analysts anticipate a slowdown, possibly even a mild recession in the US, as the Fed Reserve continues to restrict monetary policy. If inflation were to plummet faster than expected, rate hikes might decelerate, pause, or even reverse in 2023, as the effects of 2022’s rate hikes permeate throughout the economy.

Where Can Investors Turn This Year?

Given the high level of uncertainty in the global economy and political sphere, investors may be well placed to consider alternative investments. Global macro, a strategy where hedge fund managers nimbly play across marketplaces, countries, and asset classes, to capitalize on market dislocations, may be worth considering.

In a slow growth environment, equity market neutral may be effective at avoiding overall equity market beta. Private credit may also see outperformance, given the continued issues with regulatory treatment of private debt for banks removing the available supply of credit, credit spreads remaining elevated, and rates continuing to rise, as most private debt are floating rate assets.

LBO/take-private strategies may benefit from the weakness in public equity markets. Weaker overall economic growth can present opportunities for successful managers to strive to turn underperforming public companies around and effectively identify synergies and rectify inefficiencies within target companies.

Conclusion

While many of the challenges experienced in 2022 will continue to affect the economy and markets in 2023, this year may bring a host of new concerns, issues, and conflicts. Rather than worrying about the dynamics of individual assets and markets, investors may find it more effective to consider alternative assets that can capitalize on global uncertainty.

As such, many of the same strategies that performed well in 2022 may continue outperforming the public markets. Investors should identify managers with a long track record through multiple market cycles, diversified portfolios, skin in the game, and independent service providers. While many managers will reap great gains in 2023, investors should exercise caution and diversify their portfolios to strive to mitigate risks.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

How To Do a 1031 Exchange When Breaking Up a Partnership

Purchasing real estate with other investors can open new opportunities – it can allow investors to access larger assets and higher return potential. However, investing with other people can present some challenges. One of the most common issues facing partners is deciding what to do when they want to sell the asset. More specifically, what should investors do when they have different opinions on how to distribute the proceeds from the sale of the property?

Generally, when investors sell a real estate asset, they are required to pay capital gains – taxes on the profit from the sale of the property. However, the Internal Revenue Service (IRS) offers investors a unique tool to sell their real estate assets and defer capital gains. To do so, however, the entity holding the property must be the same entity purchasing the next property.

How can partners accomplish this when they disagree on what to do? They can restructure their ownership by leveraging a “drop and swap.”

What is a 1031 exchange?

Before diving into the details of a drop and swap, let’s first look at the basis for a 1031 exchange. A 1031 exchange, also known as a “like-kind exchange,” is outlined in Internal Revenue Code (IRC) Section 1031 and states that property owners can exchange real property used for business or held as an investment solely for another business or investment property that is the same type or “like-kind.”

Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts, and any other taxpaying entity may qualify for a 1031 exchange.

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The Drop and Swap

The IRS does not allow partners to sell or dispose of their partnership interests while deferring taxes if they acquire like-kind replacement property. However, a workaround solution exists in the form of the “drop and swap.” This practice allows a subset, or portion, of a partnership or LLC to engage in a 1031 exchange without the need for all parties to participate in it.

Investors can “drop” their current ownership structure and “swap” for a tenancy in common (TIC) interest. This allows investors to redistribute the proceeds from the sale of the property independently of each other.

Let’s look at an example. Alex, Kelly, and Jeff are partners in an LLC that owns real property, and they decide it is time to sell based on current market conditions. However, Alex and Jeff want to reinvest the proceeds from the sale via a 1031 exchange while Kelly is ready to cash out.

If the property is sold while held in the LLC, the only way Kelly can cash out is by the entire LLC cashing out; this results in Jeff and Alex paying capital gains before they can reinvest the proceeds.

A drop and swap, by contrast, allows the partners to drop the entity, which means the real estate is now owned through a TIC, and each investor can use their portion of the funds following the sale of the property according to their individual investment plans. Jeff and Alex can reinvest via a 1031 exchange, deferring capital gains, and Kelly can cash out and pay capital gains.

Advantages of the Drop and Swap

There are two key advantages to using a drop and swap. First, it provides investors with some additional flexibility to maneuver around their competing priorities. Second, it allows them to defer paying taxes until a later date. In addition, the 1031 Exchange process can be completed over and over, indefinitely, until the investors determine that they want to pay the taxes.

Rules of the Drop and Swap

Because a drop and swap is not officially approved by the IRS, it can be extremely risky to undertake one, and the IRS could disallow the exchange if the entity swap was done incorrectly. To help ensure that a 1031 exchange is permissible, investors would generally follow these guidelines and always consult their lawyer prior to doing anything:

Holding Period – Investors should ensure they allow a long enough holding period for the partnership to be in a TIC. Of those reporting that a drop and swap did not allow them to defer capital gains, many explain that a short holding period may have been the issue. The IRS tends to prefer the property be held for a longer period of time in order to qualify for a 1031 exchange.
Election Filing – Once an ownership structure is dropped and swapped for a TIC interest, an “election” must be filed with the IRS. According to IRC Section 761(a), an election allows the entity to avoid being categorized as a partnership.
Operating Expenses – To show that the real estate is no longer held in a partnership, all investing parties should pay their pro rata share of the property’s expenses. The longer the period, the better the case will appear to the IRS.
Negotiations – When it is time to sell, each investor needs to negotiate on their own behalf. Those who want to trade via a 1031 exchange need to make it known during the sale of the initial property.

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Completing the Exchange

It is important to note that anyone completing a 1031 exchange needs to follow the rules of the exchange as outlined in IRC Section 1031.

The exchange must be completed within a strict time frame. From the day the initial property, or “relinquished property,” closes, an investor has 45 days to identify a “replacement property” and 180 days to close on it.
The total value of the relinquished property, equity and debt, must be reinvested to defer paying the taxes; any amount not reinvested is taxable.
All replacement property must meet either the 3-Property Rule, the 95% Rule, or the 200% Rule.
According to the 3-Property Rule, investors can select up to three properties, of any value, as replacement properties and purchase one or all of them.
According to the 200% Rule, investors can identify any number of properties as replacement properties as long as their aggregate fair market value does not exceed 200% of the relinquished property’s aggregate fair market value.
According to the 95% Rule, investors can identify as many properties as they want so long as they purchase at least 95 percent of all identified replacement properties’ aggregate fair market value.
All exchanges must use a qualified intermediary (QI). A QI, or exchange facilitator, is an independent person, company, or entity that enters into a written agreement with the investor to facilitate the transfer of proceeds. It is important to use a QI because proceeds held by any party that is not a QI are taxable.

Proceed with Caution and Prepare in Advance

Parting ways is sometimes necessary among partners. Goals and objectives change, and new investment strategies emerge. While a drop and swap appears to be the solution to ownership problems in a 1031 exchange, all parties involved – especially those who want to complete a 1031 exchange and defer capital gains – should proceed with caution.

Any time investors change from one form of ownership to another, it is important to get professional help. Since there is no guarantee that the IRS will approve the exchange, it is highly recommended that everyone involved speak with a tax specialist or 1031 expert prior to selling the real estate.

General Disclosure

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

There’s no guarantee any strategy will be successful or achieve investment objectives;
All real estate investments have the potential to lose value during the life of the investments;
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
All financed real estate investments have potential for foreclosure;
These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Why NOI isn’t the strongest metric for evaluating a REIT’s growth?

The majority of investors often look for investments that offer great benefits without much risk. Individual real estate investments do provide many benefits, but they also expose investors to great financial risks as well. However, a REIT or Real Estate Investment Trust allows investors to own large income-producing properties without the burden of owning or managing the properties. A Real Estate Investment Trust is a company that owns and in most cases, operates income-producing properties. Most REITs receive income in the form of rents by leasing spaces to tenants. A REIT can be divided into two categories –

Equity REITs – Equity REITs are responsible for purchasing, managing, renovating, and administering real estate properties. They lease out spaces to tenants and then receive income in the form of rents.
Mortgage REITs – Unlike Equity REITs, Mortgage REITs (mREITs) invest in mortgages and mortgage-backed securities. A mortgage REIT lends money to real estate developers and earns interests on the mortgages. The profit of a mortgaged REIT is the spread between the interest they earn on the mortgages and the cost of financing the loan.

How Equity and Mortgage REITs make money?

Let’s consider the equity REIT first. Suppose ‘APC’ is an equity REIT. APC owns a couple of large income-producing properties and puts them on lease. Now, the rent received by APC from the rented properties is the company’s profit.

Say PAC is a mortgage REIT. Suppose, PAC raises $10 million from its investors and borrows another $40 million at 2% annual interest. Now, the company invests $50 million in mortgages that pay 5% interest. In this case, the company’s annual interest expense is $0.8 million or 2% of $40 million. Whereas, its annual interest income will be $2.5 million, which is 5% of $50 million.

Therefore,

PAC’s net income = (annual interest income – annual interest expense)
= $(2.5-0.8) million = $1.7 million

How to evaluate a REIT’s growth?

Some investors often use net operating income as a metric to determine a REIT’s potential growth. However, since depreciation expenses are subtracted from net operating income, it isn’t a precise metric for evaluating a REIT’s growth. Qualified Investors use FFO (Funds From Operations) and AFFO (Adjusted Funds From Operations) for evaluating a REIT’s growth. FFO is calculated by adding depreciation expenses and subtracting any gain or loss from the sale of the property. Let’s consider an example.

Let’s assume a REIT’s net operating income in the year 2018 was $545,989 and the depreciation expense was $414,565. Whereas, the profit obtained from the sale of the property was $330,450.

FFO = (Net operating income + Depreciation expense – profit on property sale)
= $(545,989 + 414,565 – 330,450)
= $630,104

Now, the company will use this residual income to fund dividend payments. As per the rules, a REIT must distribute 90% of its income among its shareholders as dividends.

Undoubtedly, FFO is more precise metric than net operating income for evaluating a REIT’s growth. However, it doesn’t include capital expenditure, which is also important. Once the tenure of a lease ends and a REIT leases out the property to a new tenant, they need to carry out improvement works in the property. This increases the capital expenditure and the REIT can use a portion of its income for carrying out improvement works. Therefore, qualified investors prefer AFFO over FFO for evaluating a REIT’s growth. Though there is no particular method for calculating AFFO, investors calculate it by subtracting the capital expenditure from FFO. Let’s assume the capital expenditure in this case to be $160,212.

Adjusted Funds From Operation = (Funds From Operation – Capital Expenditure)
= $(630,104 – 160,212)
= $469,892 As you can see, AFFO gives a more precise value, and that’s why it’s used by experts for calculating a REIT’s growth over the years.

Innovative ways to plan a REIT Investment

A REIT generally has large investment properties in their portfolio. A REIT usually leases properties to tenants and earns income in the form of rent, which is then divided among its shareholders. In order to qualify as a REIT, a company must comply with the following rules –

The company must invest 75% of its assets in real estate, cash or treasuries.
It must receive 75% of its income from property rents, sale of its real estate or from the interest on the mortgages.
The company must distribute 90% of its income among its shareholders. The remaining 10% can be reinvested in new properties or assets.
A REIT must have at least 100 shareholders after one year of its existence.
Not more than 50% of the shares are owned by its five or fewer shareholders during the last half of the taxable year.
The company must be taxable as a corporation.
The company must be managed by a board of directors or trustees.

How a REIT generates revenue?

Most REITs lease properties to tenants and make money from the rents, which is then divided among the shareholders as dividends. The majority of REITs trade on the National Stock Exchange and can be easily bought or sold. On the other hand, some REITs lend money to investors and earn interests on the loan. As you can see, a REIT’s source of income varies depending upon the sector in which that particular REIT operates.

Varieties of REITs

Equity REIT – Equity REITs buy, own and sell investment properties. These REITs generate revenue through rents and not by selling real estate properties. They are publicly traded on the stock exchange.
Mortgage REIT – As the name suggests, Mortgage REITs lend money to investors and earn interests on the loan. They also borrow money at low-interest rates and then buy mortgages that could pay a higher return. The spread between the two interest rates is the REIT’s profit. For example, let’s say a REIT raises $20 million through its investors. It borrows another $50 million at an interest of 2% per annum or $1 million, which is the annual interest expense of borrowing. Now, it uses this $70 million for buying mortgages that pay 5% interest or $3.5 million, which is the annual interest income generated from the mortgage. The spread between these two interest rates will be the REIT’s profit, which in this case is –

Profit = (Annual interest income – annual interest expense)
=$(3.5-1) million
= $2.5 million.

Hybrid REIT – Hybrid REITs are the ones that own and lease investment properties as well as fund mortgage loans to real estate investors. Basically, it’s a mixture of Equity and Mortgage REITs.
Publicly Traded REITs – These REITs are listed with the Securities and Exchange Commission (SEC), and trade on the National Stock Exchange. The shares of these REITs can be easily bought and sold. These REITs are regulated by the U.S. Securities and Exchange Commission.
Publicly Non-Traded REITs – These REITs are also registered with Securities and Exchange Commission but don’t trade on the National Stock Exchange. They are more illiquid than publicly traded REITs but could be more stable, as they are not subject to market fluctuations.
Private REITs – These REITs are neither listed with the Securities and Exchange Commission nor do they trade on the National Stock Exchange. They are accessible to only a few selected investors.

The majority of REITs are equity REITs. However, trusts like mortgage REITs or publicly traded REITs also have their own benefits. Therefore, it’s important that you speak to an experienced REIT advisor, who can guide you through each of these REITs more deeply. We do have a team of highly qualified advisors for you. In no time, you could speak to up to three advisors.

Invest in REITs for long-term benefits

There won’t be any human on this planet who doesn’t want a secure and stable source of income in their life, particularly after retirement. That’s why people invest in mutual funds. The return may not be high, but there is an assurance. Same goes with REITs in real estate investment. REITs provide fixed returns (subject to market fluctuations) which increases along with the age of the investment. Though not every REIT functions in this way. There are different kinds of REITs available in the market, some of which trade on the National Stock Exchange.

Variation in REITs –

A Real Estate Investment Trust or REIT is a legal trust that owns, and in most cases, operates real estate properties. This kind of investment requires long term commitment and may not suit investors who like short-term benefits. The majority of REITs lease spaces to tenants and receive rents on those properties. On the other hand, some REITs fund loans to real estate developers.

Equity REITs – Equity REITs give properties on lease and receive rents on those properties. That’s their main source of income. The majority of REITs are Equity REITs. Equity REITs generally have large institutional-grade properties in their portfolio.
Mortgage REITs (mREITs) – This kind of REITs invest in mortgages and mortgage-backed securities. Mortgage REITs lend money to real estate developers and earn interests on the loan. The profit of a mortgage REIT is calculated by taking out the difference between the interest earned on the mortgages and the cost of financing the loan.
Hybrid REITs – Hybrid REITs are a combination of Equity and Mortgage REITs. These kinds of REITs lease spaces to tenants as well as lend money to real estate developers.
Publicly-Traded REITs – These REITs are listed with the Securities and Exchange Commission (SEC) and trade on the National Stock Exchange. The shares of these REITs can be purchased the way you buy the stocks of any other company.
Publicly Non-Traded REITs – These REITs are also listed with the Securities and Exchange Commission, but they don’t trade on the National Stock Exchange.
Private REITs – These kind of REITs are only available for selected investors and held privately. Neither they are listed with the Securities and Exchange Commission nor do they trade on the National Stock Exchange.

Benefits of REIT Investment –

REIT investment is generally accompanied with many benefits, some of which are –

Regular flow of income – As a REIT investor, you can expect a regular flow of income in the form of dividends. As per the rules, a REIT must distribute 90% of its income among its shareholders, which shows how beneficial a REIT investment could be.
Liquidity – The ability of a REIT to buy and sell like other stocks or mutual funds is what makes REIT investment more beneficial. The majority of REITs trade on the National Stock Exchange, where they can be easily sold or purchased.
Transparency – As a REIT investor, you will get audited financial reports for the period of your investment. REITs provide corporate governance aligned with shareholders interests.
Diversification – With little-to-no correlation with other stocks or bonds, REIT investment is free from how other stocks behave on the stock exchange. When you invest in REITs, you invest in real, tangible assets that can diversify your investment portfolio.

A Step By Step Guide for your REIT Investment

Published On - July 26, 2019

It’s an investor’s responsibility to keep searching for different investment options from time to time. Real estate investment requires a lot of patience and a positive attitude even in adverse situations. Buying a property only requires capital. However, maintaining the same property for a long time requires capital as well as a significant amount of time. That’s why some investors prefer mutual fund investment or Exchange-Traded Fund (ETF) over large individual real estate investments. An alternative to a mutual fund or ETF investment is Real Estate Investment Trust.

What is a REIT?

A Real Estate Investment Trust or REIT is a company or trust that owns, manages, and in most cases, operates income-producing real estate properties. REITs allow investors to own shares in real estate properties without the burden of purchasing and managing those properties. The majority of REITs lease spaces to tenants and earn rents on those properties. While some REITs also lend money to real estate developers and earn interest on the loan. This kind of investment requires a long-term commitment and it isn’t for investors seeking short-term benefits.

Who is it for?

Any investor can invest in REITs. Whether you’re a beginner or a pro, a REIT investment offers similar benefits to everyone. However, it may not suit every investor. An investment structure like REIT is more beneficial for retirees or someone who is on the verge of retirement than someone who is young and looking for short-term investments. As REITs provide a steady flow of income for a long time, it suits people who have already hung their boots or are planning to do so.

What are the different types of REITs?

Equity REITs – Equity REITs lease spaces to tenants and earn rents on those properties. These kinds of REITs make money through rents by leasing properties to tenants. The majority of REITs are equity REITs.
Mortgage REITs (mREITs) – Mortgage REITs lend money to real estate investors and earn interest on the loan. They also invest in mortgages and mortgage-backed securities.
Hybrid REITs – These kinds of REITs function in both ways. Besides leasing properties to tenants and earning rents on those properties, these REITs also finance loans to real estate investors.
Publicly-Traded REITs – These REITs are listed with the Securities and Exchange Commission (SEC) and trade on America’s National Stock Exchange.
Publicly Non-Traded REITs – These REITs are listed with the Securities and Exchange Commission but don’t trade on the National Stock Exchange.
Private REITs – These REITs are neither listed with the Securities and Exchange Commission nor do they trade on the National Stock Exchange. These kinds of REIT investments are offered to selected investors.

How to invest in a REIT?

You can invest in a REIT the way you invest in other company’s stocks or bonds. A REIT’s stocks can be easily purchased and sold on the National Stock Exchange. When you buy shares in a REIT, you invest in the trust and not in real estate properties. That’s why a REIT investment doesn’t qualify for a 1031 exchange. Real Estate advisors or experts can help in exploring the challenges that come with a REIT investment.

Should you use FFO or AFFO as a metric to measure a REIT’s cash flow?

Published On - July 26, 2019

Over the years, REIT investment has become a popular choice among real estate investors, particularly among the retirees. With benefits akin to that offered by a mutual fund investment, REIT lets investors invest in real estate properties without the burden of purchasing and managing those properties. The majority of REITs own, and in most cases operates, income-producing real estate properties. They lease spaces to tenants and then collect rents on those properties. Whereas, some REITs lend money to real estate investors and invest in mortgages and mortgage-backed securities.

Equity or Mortgage REIT – Which is better?

Equity REITs own and operate real estate properties. The primary source of income of an Equity REIT is the rent they receive by leasing spaces to strong tenants. These kinds of REITs provide high liquidity as their shares can be easily purchased and sold on the National Stock Exchange.

Mortgage REITs (mREITs) function in a different way. They lend money to real estate investors and invest in mortgage and mortgage-backed securities. The spread between the interest earned on the mortgages and the cost of financing the loan determines a Mortgage REIT’s income.

Since the Equity and Mortgage REITs have different working models, both are beneficial in different ways. Investors seeking instant income can go with Equity REITs. However, as they trade on the National Stock Exchange, they are subject to market risks. On the other hand, those who require funds for their real estate adventures may find Mortgage REITs a blessing in disguise.

How to evaluate a REIT’s cash flow?

Some real estate analysts use FFO (Funds From Operations) as a metric to measure the revenue generated by a REIT. There is a whole formula for calculating FFO. Analysts calculate FFO by adding depreciation and amortization in the net income minus any gain from the sale of real estate properties.

FFO = Net income + Depreciation + Amortization – Gain from the sale of real estate

FFO helps in calculating a more precise value as it adds depreciation in the net income and subtracts any gain the REIT has made from the sale of its real estate. Some analysts also use AFFO (Adjusted Fund From Operations),an advanced version of FFO, to get a more precise value. While there is no derived formula for calculating AFFO, it is taken out by subtracting recurring expenditures from FFO that are first capitalized by a REIT and then amortized. It could be some minor maintenance expenses such as money spent on changing floor carpet or repairing damaged ceiling, and so on.

AFFO = FFO – Recurring Capital Expenditure

Both FFO and AFFO are used by analysts for calculating a REIT’s cash flow, and you too can use either of them. As REITs don’t need to make maintenance expenditures every day, you may ignore it. However, if you need a more precise value, consider subtracting it from a REIT’s FFO.

Real Estate Investment Trust – Who should invest?

Published On - August 2, 2019

A Real Estate Investment Trust is a company or trust that owns, and in most cases, operates real estate properties. REITs allow investors to invest in income-producing properties without the burden of going out and purchasing those properties. The business model of a REIT varies depending upon what kind of REIT it is. The majority of REITs make money by leasing spaces to tenants and then collect rents on those properties. A REIT’s benefits are akin to that of a mutual fund investment.

How a REIT is formed?

To form a REIT, a company must fulfill the following requirements –

The company must invest 75% of its assets in real estate.
The company must earn 75% of its income through the sale of its real estate.
The company must have at least 100 shareholders.
The company must be taxable as a corporation.
The company must be administered and regulated by a Board of Directors or trustees.
The company must distribute 90% of its income among its shareholders.

Which REIT Investment is better?

There is no thumb rule for investing in REITs. Depending upon the objective behind the investment, an investor can invest in any of the following REITs –

Equity REITs – This kind of REIT leases spaces to tenants and then collects rents on those properties. The majority of REITs are Equity REITs. The main source of income of Equity REITs is the rent they receive by leasing spaces.
Mortgage REITs (mREITs) – Mortgage REITs have an entirely different business model. Instead of leasing spaces to tenants, these REITs finance loans to real estate investors by investing in mortgages and mortgage-backed securities.
Hybrid REITs – A mixture of Equity and Mortgage REITs is known as a Hybrid REIT. These kinds of REITs lease spaces to tenants as well as lend money to real estate investors.

The majority of REITs are listed with the Securities and Exchange Commission (SEC) and trade on the National Stock Exchange. However, some REITs that don’t trade on the National Stock Exchange or are not listed with the Securities and Exchange Commission. Private and Non-Publicly Traded REITs are a few to name.

REITs require a long-term commitment, investors eyeing short-term benefits should stay away –

What a REIT investment requires from you is a long-term commitment. Just like a mutual fund investment, a REIT investment gets better and better along with time. It may not suit investors who are looking for short-term investment options. A REIT’s large structure makes it suitable for small investors as the entry cost is usually on the lower side that may start from as low as $500 or the price of one share. Therefore, anybody looking for a secure and stable flow of income can invest in REITs.

Do you need to be an accredited investor to invest in REITs?

What does being an accredited investor means?

There is no process of becoming an accredited investor. You don’t need to apply for a license or pass a test to qualify as an accredited investor. Instead, your wealth or to be precise your annual income determines your accreditation. As per the Securities and Exchange Commission (SEC), to qualify as an accredited investor, an investor must have an individual income of more than $200k per year or a joint income of $300k. Many real estate investment structures accept only accredited investors and non-accredited investors can’t invest there.

What is Real Estate Investment Trust (REIT)?

A Real Estate Investment Trust or REIT is a private trust that owns, and in most cases, operates income-producing real estates. REITs have large institutional-grade properties in their portfolio. Some REITs invest in the commercial sector, while some are inclined towards the healthcare sector. The majority of REITs lease spaces to tenants and receive rents on those properties. Whereas, some REITs lend money to real estate investors and earn interests on the mortgages and mortgage-backed securities. With benefits akin to that of mutual fund investment, REIT investment offers a steady flow of income for a long time.

Do I need to be an accredited investor for investing in REITs?

No, you don’t need to be one. Any investor can invest in REITs irrespective of how much wealth they possess. You can invest in a REIT just like you invest in the stocks of other companies. The majority of REITs are listed with the Securities and Exchange Commission and trade on the National Stock Exchange. Shares of a REIT can be easily bought and sold on the National Stock Exchange. As a REIT’s shareholder, you’ll be subject to receive dividends like other shareholders.

What are the different types of REITs?

There are three major kinds of REITs where you can invest –

Equity REITs – The majority of REITs are Equity REITs. These kinds of REITs works on a simple business model. They lease spaces to tenants and receive rents on those properties. The profit is then divided among shareholders.
Mortgage REITs (mREITs) – Mortgage REITs function in an entirely different way. They lend money to real estate investors and earn interests on mortgages and mortgage-backed securities. The spread between the interest earned on the mortgages and the cost of financing the loan determines a Mortgage REIT’s profit.
Hybrid REITs – As the name suggests, these kinds of REITs are a mixture of Equity and Mortgage REITs. Hybrid REITs lease spaces to tenants as well as invest in mortgages and mortgage-backed securities.

How to plan a REIT investment?

Though you can invest in a REIT with the help of a broker, you may want to consult your financial advisor or a REIT expert before that. As shares of a REIT can be bought and sold on the National Stock Exchange, a REIT investment is subject to market risks.

Everything You Should Know About Real Estate Investment Trust

Published On - August 12, 2019

Though real estate investments offer great benefits, they don’t guarantee fixed returns. Holding an investment for a long time may result in rising maintenance expenditure on the property, which increases an investor’s liabilities. To give investors a flexible and more secure investment structure, REIT investment was introduced in the United States.

What is a REIT?

A Real Estate Investment Trust or REIT is a company that owns, and in most cases, operates income-producing properties. Akin to mutual fund investment, REITs allow investors to invest in a more flexible and secure investment structure. The majority of REITs lease spaces to tenants and receive rents on those properties. That’s their main source of income. On the other hand, some REITs lend money to real estate investors and invest in mortgage and mortgage-backed securities.

How a REIT is formed?

A company must fulfill the following requirements to form a REIT –

The company must invest 75% of its assets in real estate or treasuries.
The company must receive 75% of its income through rents, sale of its real estate or from interests on the mortgages.
The company must distribute 90% of its income among its shareholders.
The company must have at least 100 shareholders after one year of its existence.
The company must be taxable as a corporation.
Not more than 50% of the company’s shares should be held by its five or fewer shareholders.
The company must be managed by a board of directors or trustees.

Benefits of REIT Investment –

Transparency – REITs are highly transparent as they disclose the capital portfolio annually and half-yearly.
Easy to buy and sell – A REIT’s shares can be easily purchased and sold on the National Stock Exchange. The majority of REITs are listed with the Securities and Exchange Commission and trade on the National Stock Exchange.
Higher Dividend – This kind of investment offers a higher dividend to investors as a REIT must distribute 90% of its taxable income among its shareholders.
Lower Risk – REITs have lower liquidity risk as compared to direct real estate investment.

Types of REIT –

Equity REITs – These kinds of REITs lease spaces to tenants and receive rents on those properties. This is the main source of earning of an Equity REIT. You can invest in Equity REITs just like you buy stocks of other companies.
Mortgage REITs (mREITs) – Mortgage REITs work differently. They don’t lease spaces to tenants, instead, they lend money to real estate investors and earn interests on the mortgages and mortgage-backed securities.
Hybrid REITs – These kinds of REITs function both ways. They lease spaces to tenants as well as lend money to real estate investors.

What’s the right time to invest in REITs?

There is no so-called right time to invest in REITs. REIT investment can be planned anytime in a calendar as it provides the same benefits irrespective of the time when the investment is made. However, you may want to consult your financial advisor or a REIT expert before investing in REITs.