REITs – Products and Markets

The following article covering the REIT (real estate investment trust) industry outlines the products and markets of the REIT business.

Leasing

Most REITs operate using straight forward business model by leasing space and collecting rent on its real estate in order to generate income which is then paid out to shareholders in the form of dividends. This goes for all areas of REITs including residential, retail, office, industrial, healthcare, self-storage, specialty, data center, timberland, infrastructure, and lodging (hotels and resorts). Leasing makes up majority of the industry revenue compared to the other services provided by REITs.

Mortgages

Mortgage REITs provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities and earning income from the interest on these investments. Mortgage REITs are typically not as common as leasing so they don’t make up as much of the industry revenue.

Property Management

Since public REITs are usually offered on an exchange they offer services to manage investors’ money in real estate. Depending on the REIT bought it can be a REIT specifically in the leasing segment, the mortgage segment or a mixture of the two. As mentioned above the most common REITs offered are ones that operate income-producing real estate.

Other Activities

Other activities include land development and acquisitions. These activities ultimately lead up to their end goal which is to own and manage income-producing real estate. Acquiring and development do take up majority of the REITs expenses because REITs are constantly looking for growth.

Demand Determinants

Demand for REITs is generally associated with corporate expansion and a rise in consumer spending. REITs can be influenced by a number of factors including interest rates, availability of finance, company profitability, current and expected rates of general economic growth, expected yield on investment, taxation treatment, vacancy rates of existing building stock, changes in population and changes for demand of the types of buildings.

Office Space Demand

Office space demand flows with economic cycles, as business expansion generally occurs with strong economic growth and declines with weak economic cycles. The office space segment can cover many different segments from finance, healthcare, insurance, communications, law and entertainment. Usually demand for the space will increase with new firms entering the market or when businesses look to expand. The demand for buildings can also vary depending on the type of building from the three main segments: class A, class B, and class C. Also, the ability to work remotely has impacted demand causing businesses to use less office space.

Retail and Lodging Space Demand

Consumer spending directly coincides with the expansion of retail operations. Retailers require space that is highly visible and conveniently located. Retailers that are looking for space in malls generally rely on foot traffic and sales metrics to make lease determinations

Lodging demand can be directly attributed to the growth in domestic and international tourism; major cultural, sporting, entertainment and business events; growth in casino licenses; and an area’s existing supply of accommodation.

Industrial Demand

Industrial space demand is largely linked to market conditions, industry trends and the proximity of distribution channels. Accessibility and distribution of manufactured goods along with local tax regulations are important considerations for determining demand.

Self-Storage

The self-storage REIT sector is somewhat recession resistant. More surprisingly is the fact that corporate customers make up a significant portion of storage rentals. Other significant demand factors that affect self-storage are population growth, percentage of renter-occupied housing units, average household size, average household income, supply constraints and economic growth.

Healthcare

This REIT sector is fairly immune to the recession. The demand has been increasing because of the growing elderly population, which has also increased demand for medical services. Other factors that affect demand are consumer preferences and views on retirement living.

Data Center

The datacenter sector is expected to continue to thrive regardless of the pace of macroeconomic growth. Absorption rates have reached record highs, with 357.85 MW in the top U.S. markets and 46.3 in the top Canadian markets, highlighting the still-rampant momentum. Increasing demand for cloud-based services is fueling data center leasing activity. Climate has been influencing the demand for location strategy as more data centers users evaluate performance from socially responsible, environmental and financial perspectives. The thirst for data will continue even if the broader economy slows.

Major Markets

The REITs industry can be divided into 11 major market sectors: residential, retail, office, industrial, healthcare, self-storage, specialty, data center, timberland, infrastructure, and lodging (hotels and resorts) REITs.

Residential

Residential REITs include REITs that specialize in apartment buildings, student housing, manufactured homes and single-family homes. The biggest danger for residential REITs is over construction within a particular geographic area during a declining economic environment. In such cases where supply is increasing as demand is decreasing, the management team is forced to reduce rents to keep occupancy rates stable.

Retail

Retail REITs focus on large regional malls, outlet centers, grocery-anchored shopping centers and power centers that feature big box retailers. Net lease REITs own freestanding properties and structure their leases so that tenants pay both rent and the majority of operating expenses for a property. The retail sector is also split into three general classes: Class A, with tenant sales of at least $400.00 per square foot; Class B, with tenant sales of less than $400.00 per square foot; and Class C, with tenant sales of less than $250.00 per square foot.

Office

Office REITs own and manage office real estate and rent space in those properties to tenants. Properties can range from skyscrapers to office parks and some office REITs focus on specific types of markets, such as central business districts or suburban areas. The office sector is also split into three general classes: A, B and C. Class A offices are characterized as high-quality and in common areas, class B offices are characterized as slightly lower in quality and in less common areas, and class C buildings are characterized as the cheapest buildings and in least common areas.

Industrial

Industrial REITs typically focus on properties such as warehouses and distribution centers. Industrial REITs play an important part in e-commerce and are helping to meet the rapid delivery demand. Industrial properties tend to generate steady, predictable cash flow thanks to high lease renewal rates and low capital expenditure and maintenance requirements.

Healthcare

Healthcare REITs own and manage property types including senior living facilities, hospitals, medical office buildings and skilled nursing facilities. This REIT sector is fairly immune to the recession, although they are largely dependent upon the financial health of the lessee which, in turn, rely on the medical reimbursements provided by the U.S. Government. Federal changing in health policy would obviously have a significant effect on health care REITs.

Self-Storage

Self-storage REITs own and manage storage facilities and collect rent from customers. Self-storage REITs rent space to both individuals and businesses. The self-storage REIT sector is somewhat recession resistant. More surprisingly is the fact that corporate customers make up a significant portion of storage rentals.

Specialty

Specialty REITs own and manage a unique mix of property types and collect rent from tenants. Specialty REITs own properties that don’t fit within the other REIT sectors. Examples of properties owned by specialty REITs include movie theaters, casinos, farmland and outdoor advertising sites.

Data Center

Data center REITs own and manage facilities that customers use to safely store data. Data center REITs offer a range of products and services to help keep servers and data safe, including providing uninterruptable power supplies, air-cooled chillers and physical security.

Timberland

Timberland REITs own and manage various types of timberland real estate. Timberland REITs specialize in harvesting and selling timber.

Infrastructure

Infrastructure REITs own and manage infrastructure real estate and collect rent from tenants that occupy that real estate. Infrastructure REITs’ property types include fiber cables, wireless infrastructure, telecommunications towers and energy pipelines.

Lodging

Lodging REITs own and manage hotels and resorts and rent space in those properties to guests. Lodging REITs own different classes of hotels based on features such as the hotels’ level of service and amenities. Lodging REITs’ properties service a wide spectrum of customers, from business travelers to vacationers. The lodging sector is the one most closely tied to the overall economy. When times are bad, people travel less for business and pleasure, cutting right to the heart of these company’s bottom lines. As a result, investors in hotel REITs have to concern themselves not only with overbuilding but the economic outlook of both the geographic area in which the hotel or resort is located, as well as that of the entire country as well.

Mortgage

A mortgage REIT is a company that specializes in underwriting, acquiring and holding debt obligations guaranteed by real estate properties. Mortgage REITs are essentially loan portfolios as opposed to ownership of the asset, as is the case with their equity counterparts.

International Trade

The industry is comprised of properties that are located in the U.S. and international trade is not applicable. However, the industry does contain firms that own properties abroad. For more information visit the Industry Globalization of this report.

Business Locations

Majority of the REIT owned properties across America are on the East, however there are some other major markets in California, Texas, Colorado, Washington and Nevada.

Charlie Izaguirre contributed to this report.

Nate Nead
Nate Nead
Nate Nead is a licensed investment banker with Four Points Capital Partners, LLC and Principal at Nead, LLC. Nate works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. Four Points Capital Partners, LLC is a member of FINRA and SIPC and registered with the SEC.