REITs — Real Estate Investing Without Being a Landlord

REITs — Real Estate Investing Without Being a Landlord

An apartment building earns rent while you sleep. That is the appeal of property, and it is also why property makes a bad second job: the boiler does not care that you already have a first one. A REIT separates the two. You own a slice of the buildings; somebody else owns the boiler.

The structure is not a marketing invention. To keep its tax exemption, a US REIT has to distribute at least 90% of its taxable income to shareholders, and the German REIT law of 2007 copied the same rule. That one obligation explains both the high distribution yields and the limited growth, because a company that hands over nearly everything it earns cannot fund much out of its own pocket.

The 90% applies to taxable income, not to cash flow. In a weak year a REIT can distribute more than it earned, which is a return of capital rather than profit. A large distribution is not evidence that the buildings are doing well.

Why the 90% rule makes the price jumpy

Because almost all of the income leaves the company, growth has to be financed with new shares or new debt. That is the trade an investor accepts: income today, in exchange for a company that cannot reinvest much of its own money.

The second consequence is more expensive. A REIT is priced as an income stream, and income streams are valued against interest rates. A share paying a €4 distribution is worth roughly €133 when the market demands a 3% yield and €100 when it demands 4%. Same €4, same buildings, a quarter of the value gone.

That is why REIT prices fall when bond yields rise and the rents are fine. It is the most useful fact to hold before buying one.

What a 4% distribution does over twenty years

Assume a €10,000 position in a REIT fund with a 4% distribution yield.

Take the money out and spend it, and you collect €400 a year — €8,000 across twenty years — while still holding €10,000 of shares.

Reinvest it, and the position is worth €21,900 after twenty years: 10,000 × 1.04^20. The difference is €11,900, and it splits cleanly. About €8,000 of it is the cash you chose to spend, and roughly €3,900 is what those distributions earned once they were left to work.

There is an inflation problem hiding in the spent version. A €400 distribution that never grows buys, after twenty years of 2% inflation, about what €269 buys today. A distribution that does not rise is a pay cut in installments, which is why the growth rate of the payout matters as much as its starting level.

The borrowing inside the wrapper

A REIT does not buy buildings with your money alone. Most carry debt, typically somewhere between a third and a half of the portfolio value. That borrowing is where the returns are made and where they are lost.

Take €100m of property, €40m of debt and €6m of net operating income. At 4% interest, €1.6m goes to the lender and €4.4m is left for €60m of equity: 7.3%. If refinancing costs 6% instead, the interest bill is €2.4m and the return on equity drops to 6.0%, an 18% cut in what is left for shareholders — caused by two percentage points on the loan, not by a single tenant leaving.

The multiplication runs in both directions, which is the point of the structure — and the risk. Debt does not fall when the buildings do.