A Caveat Before Investing In An Apartment REIT
I have been investing in apartment properties and commercial real estate for over 13 years now. And when I say "investing" I mean I buying and managing my own properties, not investing through REITs. This hands on experience has given me some insights that may be of help to you if you are considering and apartment REIT investment. What Do REITs Do?The main objective of an apartment real estate investment trust (or any type of REIT for that matter) is to pass the cash flows of its assets through to the trust owners or "unitholders". It is this cash flow that is most attractive to investors like you and me. And it stands to reason that the greater the amount of cash flow that is distributed to unitholders, the greater demand there is to invest in the trust.Unfortunately this scenario creates a dichotomy between maintaining distribution rates (through maintaining or increasing cash flows from the underlying assets) and maintaining the actual physical condition of the underlying assets, ie the apartment properties themselves. Slowly Killing The Apartment REITs Golden GeeseThe last thing the directors of an apartment REIT want to do is lower the monthly distribution to its unitholders. This signals problems to investors. Knowing this, the management will typically do everything in its power to avoid this scenario.How do they do it? Like I alluded to above, all too often the physical condition of the investment properties themselves are sacrificed in order to maintain cash flows. In the short run this may not be a problem, or at least one that is apparent to potential investors like you and I. But the "downward spiral" as I call it has begun.
I have seen this many times, and not just with apartment REITs. Individual owners of income properties fall into the same trap all the time. They constantly suck all the cash out of their properties that they can in the short run, slowly killing the golden goose. The condition of the property slowly deteriorates, the rents that can be charged diminishes, the quality of the tenants is lowered and the downward spiral begins. At some point the owners wake up and see the problem, but usually it is too late. Cash flows have dried up, and there is no money to improve the physical presence of the property. The usual solution? SELL FAST! Opportunity For The Smart Real Estate InvestorThis is typically where investors like myself step in. These types of properties are ripe for the picking...
These type of real estate investment opportunities are where you should be focusing your efforts if you are considering investing in revenue properties. What Happens To An Apartment REIT In This Scenario?When the curtain is finally pulled back and investors see that the "geese are dying" the price of the trust units will decline accordingly. Depending on how bad things are, the REIT may be forced (just like the individual owner) to sell off assets to survive. Again, it is a downward spiral.What To Look For In An Apartment REITLook closely at the operating statements of the REIT, not just the distribution figures. Are the expense figures in line with industry norms (typically in the 45% range)? If NOI's are running above 60% of revenues, this may be a signal that too much cash is being sucked out of the properties.Should You Invest Directly In Apartment Buildings?
As I mentioned above, if you would like to learn more about investing in apartment buildings, I would recommend that you consider a course written by a colleague of mine entitled "How To Buy Your First Apartment Building". And if you are interested in staying in touch please feel free to sign up for my newsletter. It's complimentary and I promise not to bombard you with emails!
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