There are real estate investment trusts, or REITs, that invest in just about every type of commercial property and real estate-related asset you can think of. And that, of course, includes office-focused REITs such as City Office REIT. Office buildings offer excellent potential for steady income, as well as capital appreciation, with relatively low risk compared with other types of commercial real estate.
Although they are a relatively low-risk form of REIT investment, there is still plenty you should know before buying your first office REIT. Here’s an overview of what office REITs are, risks you should know about, and some examples of major office REITs to get you started.
What is an office REIT?
Real estate investment trusts, or REITs, are a special classification of corporation. REITs’ businesses primarily consist of owning, operating, developing, and/or managing real estate assets. According to industry group NAREIT, though, in order to qualify as a REIT, a company needs to meet some pretty specific criteria, including:
- A REIT must pay out at least 90% of its taxable income as dividends to shareholders. This is the most widely-known REIT qualification.
- A REIT must invest at least 75% of its assets in real estate or related assets.
- A REIT must derive at least 75% of its income from real estate or related activities.
- A REIT must have a minimum of 100 shareholders.
- No five investors can own more than 50% of the shares of a REIT. Individual REITs often deal with this by restricting the ownership of any single investor to 10%.
In exchange for meeting all of these requirements, REITs enjoy a big tax advantage. Specifically, REITs don’t pay any corporate taxes on their profits, no matter how much money they earn. Because of the requirement that they distribute most of their income, REITs are treated as pass-through businesses.
Most dividend-paying stocks effectively have profits taxed twice -- once at the corporate level, and again on the individual level after they’re paid as dividends to shareholders. Although most REIT dividends don’t get the preferential "qualified dividend" treatment by the IRS, this is still a huge tax advantage.
Most REITs specialize in a certain type of commercial property. As their name implies, office REITs own, manage, and/or develop office buildings. There are office REITs that invest in suburban office parks, REITs that invest in super-luxurious office skyscrapers in urban areas, and everything in between. These office buildings are then leased to tenants seeking office space.
Risks of investing in office REITs
Office REITs are certainly lower-risk than most other types of equity REITs, as we’ll see in this section and the next. Having said that, no stock that’s capable of market-beating returns is without risk, and these are no exception. So, here are some of the key risk factors that office REIT investors should be aware of:
Interest rate risk
No discussion of REIT investing would be complete without mentioning interest rates, which can have a huge influence over REIT stock prices. While there’s a lot more to the story than I can discuss in a paragraph or two, the main principle to know is that rising interest rates are generally a negative catalyst for REITs stock prices. The 10-year Treasury tends to be a good REIT indicator, and as you can see, this risk-free yield and REIT prices move in opposite directions most of the time: