By Jonny Lupsha, Wondrium Staff Writer
A landmark sellers’ market in the housing industry is blowing up Google. Homeowners and would-be buyers have watched houses sell for $40,000 and even $80,000 over list price. Real estate is one of the most popular tangible assets.
The housing market has been on fire the last year due to the amount of people working from home. Properties are selling for tens of thousands of dollars over their listing price, sometimes fetching dozens of high offers.
However, as history has shown, eventually all bubbles have to burst. This is likely one of the reasons that Google reported that the amount of people searching on “When is the housing market going to crash?” went up nearly 2,500% in the last month. Far from being sour grapes, these searches could be inspired by any number of market crashes in the last century, including the 2008 subprime mortgage crisis.
In his video series Understanding Investments, Dr. Connel Fullenkamp, Professor of the Practice and Director of Undergraduate Studies in the Department of Economics at Duke University, explained one popular investment, a real estate investment trust.
REIT Where It Belongs
“Generally, real estate markets don’t move in lockstep with the stock and bond markets, and this means that they can provide good diversification,” Dr. Fullenkamp said. “But you have to find an investment that is more closely connected to real estate markets than government-guaranteed mortgage-backed securities.”
One such investment is a real estate investment trust (REIT). A REIT, according to Dr. Fullenkamp, is very similar to a closed-end mutual fund in its organization: It’s a company that sells shares to investors once, at the beginning of the fund, and uses those proceeds to invest in a portfolio of real estate assets. The shares of a REIT trade on the stock exchange.
“The big difference between REITs and closed-end mutual funds, though, is that REITs are required to pay out at least 90% of their income as dividends to the shareholders,” Dr. Fullenkamp said. “This means that REITs can be attractive for their dividends as well as for the possibility of capital gains. The capital gains on REITs have tended to be modest, so the returns on them have primarily been delivered through the dividends they pay.”
Two Kinds of REITs
Dr. Fullenkamp said that there are two main kinds of REITs and that 90% of them are the first kind: an equity REIT.
“Equity REITs invest directly in real estate—buildings and land,” Dr. Fullenkamp said. “They buy buildings and manage them, or even develop real estate projects and manage them. Mortgage REITs, on the other hand, invest in mortgages and mortgage-backed securities.”
According to Dr. Fullenkamp, either REIT is fine to invest in, but mortgage REITs are highly leveraged; so, they have to devote a lot of attention to hedging the interest-rate risk that comes together with that higher leverage. He said he doesn’t recommend mortgage REITs unless you feel very comfortable evaluating and monitoring highly leveraged investments.
“The other thing that you’ll want to pay attention to is the type of property that the REIT intends to invest in,” he said. “A lot of REITs invest in retail space, like shopping malls and strip malls; office REITs invest in office buildings, which can be in the hearts of big cities but can just as easily be in the suburbs.
“Health care REITs invest in hospitals, clinics, nursing homes, and retirement communities; and, of course, there are residential REITs, which mainly invest in multifamily homes and apartment buildings. There are even hotel REITs.”
If the housing market seems attractive to you, Dr. Fullenkamp recommends doing your homework and learning about what a REIT holds and what its returns should be.