Introduction to Hybrid REITS
Part Mortgage Real Estate Investment Trust, Part Equity REIT
The National Association of Real Estate Investment Trust (NAREIT) lists the number of publicly traded Hybrid Real Estate Investment Trust (REIT) at 7. Interestingly, Hybrid REITs are the only group of REITs to experience a decline in total number in the marketplace. Compared to the eleven-fold increase in Equity REITs and the modest three-fold increase in mortgage REITs in the past 25 years, Hybrid REITs seemed to be languishing.
A more telling sign lies in the capitalization story. In 1972 Hybrid REITs made up 40% of the entire REIT industry market capitalization. Fast forward to 2006 and this percentage now stands at less than 2% and is declining. At this rate Hybrid REITs may no longer exist in the next five to 10 years. Investors are left to wonder, what happened here?
Hybrid Real Estate Investment Trust Introduction
Hybrid Real Estate Investment Trusts are a category of investment vehicles that invest in mortgages as well as directly in hard real estate assets. These vehicles differ from other diversified strategies because they incorporate debt and equity investments. Other diversified strategies might include residential and office or hotel and industrial. While these also qualify as diversified strategies for the purpose of this paper they will be categories as Equity REITs because the REIT has an equity stake in the investment.
The NAREIT defines an Equity REIT as a REIT which owns, or has an "equity interest" in, real estate.[1] This is important because it speaks directly to the risk associated with equity REITs. An equity interest stake allows the REIT to directly participate in all gains or losses associated with a particular asset.
Mortgage REITs are defined as a REIT that makes or owns loans and other obligations that are secured by real estate collateral. In contrast to Equity REITs, the underlying property value is only one component of the risk associated with Mortgage REITs. Mortgage REITs have additional and significant exposure to interest rates.
The Diversification Story
Hybrid REITs combine both strategies in an attempt to diversify real estate investment alternatives. When interest rates are high, Equity REITs will suffer because their capital will be more expensive. Consider the capital asset pricing model. As rf increases the expected return of equity or cost of equity must also increase. Additionally, many equity REITs use the debt markets to fund some portion of their investments. Even though REITs do not get the tax benefits of interest expense deductions, debt capital may still be less expensive than equity capital. Finally, the payout requirements placed on REITs force REITs to constantly raise debt and equity for future investments.
[1]http://www.investinreits.com/learn/glossary.cfm , 5/5/07
