How do REITs work? A Short Attempt at a Storey

A REIT is a trust company.

A trust company is a legal entity. A trust company is a legal entity that acts as a fiduciary.

Alright, if you’re anything like me, you’re probably wondering–here comes the legal mumbo jumbo that will put my brain on snooze. Oh what a lovely bedtime story! Forget fairy tales and happily ever afters. Bring on the legal documents–that’ll definitely put you straight to sleep.

But I highly encourage you not to fall asleep. This is important stuff we’re talking about.

So what is a fiduciary? It sounds like a fancy word, doesn’t it! English is my first language, but still, a fancy word, indeed.

There are two components to the concept of fiduciary.

  1. It can either be a person or organisation
  2. A fiduciary acts on behalf of another person or persons.

Ok phew. We got that out of the way. Also, I am not a lawyer. I am an accountant. Lawyers and accountants need each other, but still, they don’t seem to get along.

Rather, strange, don’t you think?

Anyways, now back to our legal definition… Zzz…

A fiduciary needs to put their client’s interest ahead of their own. They also have a duty to preserve faith and trust. They are bound both legally and ethically to act in the other’s best interests.

Ok–so there you go. This part we get. I hope we do, at least.

So why entrust your money to a trust company? Because perhaps you want to invest in a REIT, but you perhaps don’t possess the large-scale capital it takes to actually do something like that.

If you were looking to fund a large real estate project, you can either raise equity or use debt. On the flip side of this equation, you can either be the one who lends the money or provides the equity. In both cases, you take up some risk in exchange for a greater future return.

A trust company–in this case–the REIT, is typically tasked with the administration, management and the eventual transfer of assets to beneficiaries.

So, essentially, they run the place, but don’t own it.

There’re probably a lot more technicalities to this definition, but I think this is enough for our purposes… for now.

Now, coming back to the whole idea of a REIT works.

A REIT is a trust company that pools together funds from investors and applies that money to acquire a property or group of properties which they will then manage, develop and possibly sell later on.

From the investment perspective, the REIT gets its money when investors subscribe for units in the REIT in either an IPO or via a placement or rights issue undertaken by the REIT.

From the management perspective, the manager’s task is to lease the properties out to obtain rental income for distribution to its unitholders.

A good fiduciary would (and certainly should) attempt to maximise the income stream from the properties in question. To do so, the manager of the REIT may choose to renovate, upgrade, tear down, rebuild, redevelop and perhaps even sell the property.

And that’s all folks…

Till our next lesson…

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