Key Points

• Real estate investment trusts (REITs) are listed on stock exchanges and can be bought and sold just like stocks.
• REITs operate similarly to mutual funds with a collection of assets and a management team.
• Over 50 REITs are now listed on the London Stock Exchange, offering dividend income to investors.

Real Estate Investment Trusts (REITs) were first created in the United States in the 1960s. American Realty Trust, founded in 1961, became the first REIT stock in existence. Since then, over 39 countries have adopted the financial instrument. And at the beginning of 2021, the stock market capitalisation of global REITs reached $1.7trn. 

Here in the UK, real estate investment trusts were introduced through the Finance Act of 2006. In January 2007, the Act became effective as nine UK property companies gained REIT status. Today, there are over 50 REITs listed on the London Stock Exchange.

But what makes these companies so special? And should I be considering them for my portfolio?

What are REITs, and how do they work?

Real estate investment trusts are a type of business or group of companies that owns and manages income-generating assets on behalf of their shareholders. Typically these assets consist of real estate properties, but that’s not a fixed rule. For example, Foresight Solar Fund is a REIT that owns a collection of solar farms.

Investing in REIT shares works identically to buying and selling ordinary shares of any other stock or fund. And much like a mutual fund, a REIT pools together money from lots of different investors. The management team then takes this money and invests it in various assets.

It’s a financial instrument that enables individual investors the ability to invest in properties that would normally not be available. For example, offices, swimming pools, hospitals, shopping centres, wind farms, hotels, parking lots, warehouses etc.

Using the proceeds generated from its portfolio of assets, typically in the form of rental income, the management team then redistributes it to shareholders through dividends.

What makes REITs different from any other holdings company? It’s all to do with taxable income. A registered real estate investment trust is immune to corporation tax. However, a key requirement is that 90% of the net earnings must be distributed to shareholders in dividends.

As such, these financial instruments are often a lucrative source of passive income for investors with high dividend yields.

Are real estate investment trusts a good investment?

As exciting as a mandatory dividend sounds, there are some caveats to consider. Firstly, there is no guarantee that a real estate investment trust will generate a profit, and therefore nothing to pay dividends from.

Much like any business, a REIT has its ups and downs. Plus, with the majority of earnings being redistributed to shareholders, the degree of financial liquidity can often be very tight.

Furthermore, if these companies want to rapidly expand their asset portfolios, it’s often impossible without external financing. This can result in debt-heavy balance sheets, aggressive equity dilution, or both, despite large amounts of cash flow.

Needless to say, with interest rates on the rise, having a large pile of loan obligations isn’t ideal.

But under ideal circumstances, even with these limitations, REITs can deliver a steady stream of passive income through dividends. And providing demand for its assets rises, the value of a REITs portfolio, and therefore share price, can increase substantially, enabling investors to enjoy capital appreciation as well as income.

That’s why I believe real estate investment trusts have an important role to play in my investment portfolio.

What are the highest paying REITs in the UK?

Here are the top 10 highest paying REITs in the UK in order of dividend yield.

Top 10 REITs by market capitalisation

On the other hand, here are the top 10 UK REITs in order of market capitalisation.

Should I invest in a real estate investment trust?

A REIT investment has its advantages and disadvantages. And whether or not they belong inside an investor’s portfolio is highly dependent on their financial objectives.

Personally, the ability to invest in assets that would otherwise be unavailable, as well as receive a reasonable, reliable source of passive income, sounds interesting. Therefore, I’m keen to add real estate investment trusts to my portfolio.

Prosper Ambaka does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.