We mentioned previously in Real Estate Investment Trust Reit Dividend Yield what Dividend Yield is. We also talked about the perks of investing in REITS in Why and how to invest in Reits. However, we have rarely talked about how a REIT works and that will be what we intend to flesh out today.
A REIT is an investment vehicle that owns or have interest in stable cash flow generating properties. The income generated from these REITS are not taxed but the condition is that 90% of the total distributable income must be distributed to the shareholders.
Most of the time a developer will create an associated REIT and use it as a platform to recycle capital. One example of this relationship is how Capitaland Commercial Trust and Capitaland Mall Trust are Reits to its parent Capitaland. The parent will inject stable properties into the Reit and invite outside investors to own a piece of the reit through an IPO.
If the properties that are injected into the REIT are good quality ones, it is a win win both for the investors as well as the parent company. For the investors, they get to participate in real estate returns that are otherwise difficult to get due to the high capital outlay required for individual investment in physical real estate. For the parent company, they tend to get higher capital returns via development of real estate. Hence recycling capital through the Reits will enable the parent to re deploy the initial capital into high yielding investments, all while retaining control of the properties, through its property management arm.
After the initial creation of the Reit, the parent can continue to inject properties into the former. This is often detailed in a Right of First Refusal, in which the Reit has the right to be given the first opportunity to acquire the property from its parent. If it deems the property to not meet its own investment mandate or hurdle rate, the parent will then put it up to the secondary market for others to acquire the property.