Real Estate Securities Basics

Real estate securities provide investors with the benefits of owning commercial real estate without expending large amounts of capital. They also generate stable returns, which has resulted in rapid growth of the real estate securities market. However, before diving into real estate investments, it is important to understand the unique features of this asset class.

What Are Real Estate Securities?

Real estate-based securities represent an indirect investment in something related to real property, i.e. hotels, office buildings, apartments, medical facilities, warehouses, etc. There are many different types of real estate-based securities. They include:

• Real estate development projects
• Real estate investment trusts
• Mortgage investment companies
• Real estate joint ventures
• Land banking (purchasing and holding undeveloped property and then conveying it to the developer)

Understanding REITS

Real estate investment trusts (REITs) are by far the most common type of real estate security. A REIT owns and/or operates income-producing real estate or related assets and allows investors to buy shares. Investors can earn profits from dividends or an increase in the value of the REIT’s shares.

What is the Principle Real Estate Securities Fund?

The Principal Real Estate Securities Fund offers investors access to a diversified portfolio of publicly traded real estate securities, including real estate investment trusts (REITs) and related companies.

REITs often own many properties. Some have diverse real estate portfolios, while others focus on a particular property sector, industry, or geographic region. Many REITs are publicly traded and registered with the Securities and Exchange Commission (SEC). A minority are private funds whose shares are generally only eligible for purchase by accredited investors.

REITs are not required to pay corporate taxes on the income and capital gains they distribute.

However, to qualify as a REIT, companies must follow specific rules defined by the Internal Revenue Service. The requirements include:

• Investing at least 75 percent of total assets in real estate, cash, or U.S. Treasuries
• Deriving at least 75 percent of gross income from rent, interest on mortgages that finance real estate, or real estate sales
• Paying a minimum of 90 percent of their taxable income to their shareholders through dividends
• Operating as a taxable corporation
• Being managed by a board of directors or trustees
• Having a minimum of 100 shareholders, with no more than 50 percent of the shares held by five or fewer individuals

Given their minimum distribution requirement and cash-flow-oriented business structure, REITs generally generate higher dividend yields than other investments. The demand for REITs has contributed to the recent expansion of the real estate securities market.

Risks and Benefits of Investing in Real Estate Securities

Understanding the benefits and risks of real estate securities is crucial for making informed investment decisions. Real estate securities provide many of the benefits of real estate ownership while minimizing the risks. For instance, buying an investment property generally requires a large amount of capital, while investors in real estate securities can select their individual financial contribution levels. Investment properties are also notoriously illiquid. In comparison, real estate securities can generally be readily traded or sold.

Real estate investing offers one of the best returns on investment (ROI), particularly when compared to other investment strategies. Adding real estate securities to your portfolio can also be a great way to diversify. Real estate has a low correlation with other major asset classes, so if the stock market drops that doesn’t necessarily mean that your real estate investments will also suffer. While real estate investments are not inflation-proof, property values and rental rates typically increase in line with general price levels, which provides protection against inflation.

Like any investment, real estate carries risks. Most importantly, there is always a risk of not earning a return or not recovering your investment. Real estate investments are often sensitive to changes in the overall real estate market as well as fluctuations in interest rates, which can impact both property values and occupancy demand. REITs that focus on specific geographic locations or property types such as malls or inner city office buildings can be significantly affected by declines in those areas. Some REITs may also come with high management and transaction fees.

Trusted Guidance on Real Estate Securities

Scarinci Hollenbeck has significant experience handling a wide range of real estate securities matters, including structuring, forming, and investing in REITs. Our clients, which include brokerage firms, institutional and private investors, entrepreneurs, developers, and real estate owners of all types, obtain comprehensive legal counsel from members of our Tax, Commercial Real Estate, and Securities practices.