How REITs May be Affecting the Commercial Real Estate Market

Author: Shane Adam Yellin on March 29, 2010

Are the benefits of high dividend yield REITs outweighed by artificial constraints propping up commercial real estate prices?
Real Estate Investment Trusts allow investors to buy into commercial properties. They often have high dividends. They are tightly controlled. But, they mask unnecessary purchasing. To be a REIT, one of the requirements is to invest at least 75 percent of its total assets in real estate assets.
REITs cannot hold cash on hand as hedge funds can. They must be invested in real estate gaining revenue from rental income and the like or interest from mortgage lending. They cannot derive any substantial income from interest by holding cash at a bank in risk-less mediums. One may argue that this fact is creating an artificial leg for the commercial real estate sector to stand on.
REITs have this obligation to spend money. This in turn causes them to compete to buy buildings, possibly bidding up the price. This bidding may be self imposed. As they must own, they may overpay to offset the obligation of holding cash. They will buy not what they necessarily want, but what they are obligated to buy. This could also affect the comparable prices used to value real estate, overvaluing them. This cascade of artificial valuation affects the current and future market as well as the REIT portfolio.
While this simple non-cash-on-hand dynamic will not prop up the market by itself, it does pose an interesting challenge for accurate valuation. REITs are very popular investments as they release a high yield dividend, but carry an awkward burden that affects the greater market.
REITs are certainly a vehicle for investment and are a great means as they are liquid and are required to pay dividends. However, as this is yet another product, one must understand the greater implications of each investment and the underlying principles governing their existence.

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