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REITs (Real Estate Investment Trusts) are investment funds that allow for indirect investing in the American real estate market. These entities, which have been around in the United States for over six decades, are currently eliciting increasing interest due to their diversification and high yield potential. So, what are they? What are the advantages of REITs and how does one invest in these funds? Here's a detailed explanation.
A REIT is a company that primarily invests in commercial real estate, with shares traded on the stock market. These vehicles can invest in different types of properties, such as office buildings, shopping centers, apartments, hotels, or warehouses. Mostly subject to US law, this investment vehicle is part of the « brick and mortar ». It is similar to the French listed real estate companies or SIIC (Listed Real Estate Investment Companies), and also has equivalents in other countries: in Germany, Belgium, or Japan, for example, with different operating rules, as well as in Quebec with Real Estate Investment Trusts (REITs). However, these remain relatively few in number. Considering American companies - which managed more than $4,500 billion in assets in 2022 - a fund must meet certain specific regulatory requirements to qualify as a REIT. For example, it must have at least 100 shareholders in its capital, primarily hold real estate assets (at least 75%), generate most of its income from these assets, and distribute 90% of its income as dividends to shareholders.
While, on paper, all these REITs fall under indirect real estate investment, these funds differ from SCPI (French Real Estate Placement Companies) and OPCI (Real Estate Collective Investment Organizations) in several aspects. - American laws: The distinction is first and foremost geographical. SCPIs and OPCIs are present in the French market. REITs, on the other hand, operate in the United States (while being open to foreign investors). Therefore, SCPIs and OPCIs are subject to French regulations, while REITs are governed by American laws. - Dollar-based funds: The other major difference is that these funds logically nominated in dollars. For French savers, this means that to acquire shares, one must first buy currencies. The cost of the exchange adds to that of the shares, and the operation puts an additional risk on the return in case of unfavorable euro/dollar parity. - Publicly traded companies: Unlike SCPIs (but like OPCIs), REITs are publicly traded companies. This means, at least in theory, that they have better liquidity when shareholders want to sell their shares. However, their value also undergoes fluctuations in supply and demand and can therefore more easily depart from the value of the assets held. - A predominant building purchase: The share of real estate investments is larger for REITs (a minimum of 75%) than for OPCIs (a minimum of 60%). SCPIs, on the other hand, must simply manage their treasury investments. - Finally, SCPIs issue shares, OPCIs issue shares or units depending on their form, and REITs issue shares.
The assets in which REITs invest can vary based on each fund's strategy. Some REITs specialize in a particular type, such as office buildings or shopping centers, while others may have a more diversified approach. Such investment diversification allows investors to gain exposure to different real estate sectors without having to manage the properties directly. This multiplies the potential for profitability while minimizing constraints, without, however, absolving risks. Thus, REITs can invest directly in real estate properties, but, contrary to their name, they can also invest in mortgages backed by real estate. In this case, it is referred to as a « mREIT », or « mortgage REIT ». mREIT funds are specific financial products: the mere fact that they are based on real estate backed mortgages might bring cold sweats among those who remember the 2008 subprime crisis. Complex in their structure, they are however very easy to acquire since the process is the same as for any stock. But investment risks are among the highest: these funds buy back mortgages from lenders (including real estate bought by REITs), often on credit. They derive their returns from the difference between the two rates, which vary over time. In case of default (economic crisis, real estate market downturn...), the fall can be devastating. For the general public, it's wiser to stay clear of them.
Let's start by clarifying that these are risky investment products by nature. The return performance depends on many factors: the evolution of the American real estate market, which is generally much more volatile than the French market, fluctuations in financial markets and rates, the performance of the fund managers' choices, and for European investors, the evolution of the euro/dollar parity. The risk of capital loss does indeed exist, even if the underlying real estate may seem reassuring. For the rest, REITs are known to be « high yield » investments. One of the main reasons is that their distribution is based on the rents they collect (excluding mREITs), which are less subject to fluctuation than companies' profits. But high potential also means high risk. The year 2022 perfectly illustrated this: REITs recorded negative performance, averaging -25.1% over a year. Underperformance compared to the stock market, the S&P 500 having dropped « only » 19.4%. Over a longer period (40 years from 1972 to 2022), the average performance comes out to about 11.26% per year, with multiple fluctuations up and down according to data from Nareit, the association of REIT professionals based in Washington. If we consider the years 2012 to 2022, the differences from one year to the next have been significant, but the average return is 9.48%. In fact, it is inferior to that of the S&P 500 by 2.25 pts (see table below). We're talking about long-term averages across all funds here. That doesn't guarantee that future performance will be equivalent, either for the overall REIT market or for certain funds in particular. Year FTSE Nareit All REITs annual return (source Nareit)S&P 500 annual returnDifference (REIT - S&P500 stocks) 2012 | 20.14% | 13.41% | +6.73 pts2013 | 3.21% | 29.6% | -26.39 pts2014 | 27.15% | 29.6% | +15.76 pts2015 | 2.29% | -0.73% | +3.02 pts2016 | 9.28% | 9.54% | -0.26 pt2017 | 9.27% | 19.42% | -10.15 pts2018 | -4.10% | -6.24% | 2.14 pts2019 | 28.07% | 28.88% | -0.81 pt2020 | -5.86% | 16.26% | -22.12 pts2021 | 39.88% | 26.89% | +12.99 pts2022 | -25.10% | -19.44% | -5.66 pts2012-2022 Average | 9.48% | 11.72% | -2.25 pts
One of the key benefits of REITs is their corporate tax exemption, provided they distribute at least 90% of their profits in the form of dividends to shareholders. This tax provision partly explains the potentially high yield of these funds. But it's also a benefit for French investors: there's no double taxation, and as they receive dividends from shares, they are taxed under the category of securities income and not real estate income. A principle that allows them to benefit from a 40% reduction.
First, it's important to understand that REITs are diversification investments. They allow for the broadening of one's investment portfolio by investing in the American real estate market. Especially considering REITs have historically shown good performance, driven by economic growth and ongoing demand for commercial spaces. However, it is difficult to predict the future of this trend, particularly in light of the risks posed by American debt. Like any investment, it's imperative to fully grasp the risks before committing any money. Similarly, since REIT shares are publicly traded, individual investors theoretically have greater liquidity than in non-traded markets.
Investing in REITs carries risks. Stock market fluctuations can lead to a loss of capital for investors, and past performances do not guarantee future ones. Obviously, the ideal would be to acquire shares at the lowest point and benefit from potential upswings in the following years. But reality is quite different. REITs are also very sensitive to changes in the American real estate market, and a drop in demand, an increase in unemployment, or an economic crisis can at any time have a negative impact on their performance. Finally, for European investors, there also exists a currency risk, since these investment funds are denominated in US dollars. A fluctuation in currency parity can be unfavorable.
To invest in REITs from France, there are several options. Investors can purchase individual REIT shares through an ordinary securities account (CTO) or use trackers (ETFs) that replicate the performance of a basket of REITs. Since REITs are American financial products, they are not directly eligible for the PEA. But some ETFs could be. Finally, some of these investment funds are also available through a life insurance or a retirement savings plan, which can benefit from the tax breaks associated with this wrapper. Check with contract providers for available supports.
