Advantages and Disadvantages of Investing in Publicly Traded Real Estate Securities

Advantages

The most likely merits of investing in real estate through publicly traded real estate securities include:

Higher Liquidity

Publicly traded real estate securities offer investors much higher liquidity than physical real estate investments since they trade daily on securities exchange markets.

The low liquidity of real physical estate investments is attributed to individual real estate property’s high value and unique nature.

Lower Investment

Publicly traded real estate investments require much smaller amounts to trade in their shares than a direct investment in a real estate property whose initiation requires a high volume of capital injection.

Limited Liability

Typically, an investor’s financial liability in a REIT is limited to the total amount invested. This contrasts with a general partnership interest whose potential liabilities supersedes the investor’s initial investment.

Access to Prime Real Estates

Individual investors find it challenging to invest in high-end properties, e.g., shopping malls, directly. Even then, investing in such ventures should be easy. An investor should just acquire shares in REITs to guarantee a stake in such prime real estate.

Availability of Professional Management Services

REITs and REOCs engage proficient managers in the oversight of the acquisition and running of real estate properties. In contrast, direct investment in properties requires expert knowledge in the management of the real estate sector.

Professional Ethics and Oversight

REITs and REOCs must strive to meet all requirements applicable to publicly traded companies, e.g., adherence to regulations on financial reporting, disclosure, and governance. Compliance with these requirements bolsters investor confidence since it is an indicator of proper monitoring of the management and the board of directors. Ultimately, this leads to financial and operating efficiency.

Room for Expansion

REITs offer investors the opportunity to expand their real estate investments across varied property types and physical locations. In this respect, REITs are different from direct investments which require a high cost to achieve.

Disadvantages

The most common disadvantages of investing in real estate through publicly traded securities include:

Losses and Tax Deductions

Direct investments in real estate allow deductions on losses against real estate taxable income. Besides, direct investments permit the swapping of one property for a similar one. Note that these transactions are not applicable in the case of REITs and REOCs. Note, however, that these transactions are dependent on respective local laws.

Lack of  Absolute Decision-making Autonomy

Compared to direct investment in properties, investors in REITs and REOCs enjoy minimal investment decision-making autonomy.

Investment Costs

The initiation of smaller REITs can be capital intensive. This makes investment in them uneconomical.

Price Volatility

Despite the appraisal-based value of a REIT being moderately steady, the price of a REIT share determined by the market is predominantly more volatile than that of direct real investment.

Conflicts of Interest

The structure of a REIT may occasion a conflict with investors. This may, for example, happen when an offer arises to dispose of properties or undertake additional funding through debt. Such circumstances may call for decisions that may have significant tax implications for REIT shareholders and other key partners. This may tempt the key strategic partners to act in their interest rather than that of the shareholders.

Moderate Income Growth Potential

REITs exhibit a relatively low-income retention rate. This leads to a low reinvestment for future growth, thereby reducing income growth potential. The stock market’s tendency to pay attention to earnings growth can lead to underperforming REIT shares. This happens when the market valuation of high-performing companies corresponds with high consumption, business, and investor confidence.

Possibility of Forced Equity Issuance at Disadvantaged Prices

REITs often utilize financial control and are constantly in the debt markets seeking to refinance their maturing debts. Equity issuance at diluted prices, especially during periods of partial credit accessibility, can occur when a REIT’s management of its overall financial control, the timing, and debt maturity types is weak. This leads to a lack of significantly reserved cash flow.

Question

Which of the following is most likely to be an advantage of publicly trading real estate securities?

1. Price volatility.
2. Losses and taxation.
3. Increased liquidity.

Solution

The correct answer is C.

Investment in publicly traded real estate securities affords investors greater liquidity than physical real estate properties. This is because they trade daily on the securities exchange.

A is incorrect. Price volatility is a disadvantage of publicly traded real estate securities.

B is incorrect. Losses and taxation are disadvantages of publicly traded real estate securities.

Reading 37: Investments in Real Estate Through Publicly Traded Securities

LOS 37 (e) Explain advantages and disadvantages of investing in real estate through publicly traded securities compared to private vehicles.