For decades, Real Estate Investment Trusts (REITs) were the go-to option for people looking to invest in real estate with very little upfront capital. For as little as a few dollars, you could own stock in a publicly-traded REIT and earn passive income through a consistent dividend. Nowadays, the complicated fee structures behind REITs are akin to the high fees charged by mutual funds and investors are starting to take notice.
We get asked all the time if addy is a REIT. The short answer is no, we are not a REIT. REITs are companies that own a large portfolio of income-generating property and payout 90% of their taxable income to the company’s shareholders. Check out our article comparing rentals, REITs, and crowdfunding platforms for more information on this topic.
REITs can be good investments (in some cases), but – as with any investment – it’s best to go into it with your eyes wide open. This article will help you better understand the fees that are often accompanied by investing in REITs.
Pulling Back The Curtain On REIT ETFs
The benefit of investing in a REIT is that you can get automatic diversification and – in some cases – exposure to hundreds of investment properties through a single stock. However, many investors look to diversify even further and choose to invest in REITs through something called an Exchange-Traded Fund (ETF).
First, What are ETFs?
Here’s Investopedia’s definition of an ETF: An exchange-traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index.
So what does this have to do with REITs?
REITs are typically made up of a portfolio of properties that fall into one particular asset class such as retail space or office buildings. To diversify across these asset classes, investors will use a REIT ETF – a single stock that is basically a bundle of different REIT stocks.
Over the past two decades, investors have flocked to ETFs. Between 2003 and 2019, worldwide ETF assets under management grew from $204 billion to over $6.1 trillion. This represents an annual compounded growth rate of 23% for the adoption of ETFs.
Source: Worldwide; Deutsche Bank; Bloomberg; Thomson Reuters; 2003 to 2019
When investors use REIT ETFs, they are typically charged management fees and other expenses that cut into their returns. To understand these expenses, you should be familiar with two concepts in particular: management fees and management expense ratios.
Investors hear about management fees all the time, but what exactly are they? Simply put, management fees are the fees charged by investment managers for overseeing an investment fund.
These fees can range anywhere from 0.05% for a low-cost index fund up to 5% or more for the world’s top hedge funds.
Management fees can make or break an investment decision, so it’s crucial to keep them in mind when choosing which investments to include in your portfolio.
Management Expense Ratios
Management expense ratios – often referred to as MERs – are a combination of management fees and any additional fees needed to pay for the administrative overhead costs incurred by a fund.
The MER is used by investment managers to determine how much of an investment fund’s assets are needed each year to cover the investment fund’s operating and administrative expenses.
This ratio can be easily overlooked by the everyday investor, but it is important to understand because investments with unnecessarily high MERs can hurt your returns in some cases.
Here’s a table showing the MERs and fees behind Canada’s top-performing publicly-traded REITs.
|ETF||YIELD||FEES||MANAGEMENT EXPENSE RATIO|
|BMO Equal Weight REITs Index ETF||5.5%||0.55%||0.61%|
|CI First Asset Canadian REIT ETF||5.3%||0.75%||0.90%|
|iShares S&P TSX Capped REIT INDEX ETF||4.8%||0.75%||0.61%|
|Vanguard FTSE Canada Capped REIT Index ETF||4.1%||0.35%||0.39%|
|Purpose Real Estate Income ETF||3.9%||0.65%||0.78%|
Source: Yahoo Finance, 2020
Fees Behind Private-REITs
Not all REITs are traded on stock exchanges like the NYSE or the TSX. Many of the highest-yielding REITs instead raise capital through accredited investors (aka. high-net-worth individuals). These non-traded REITs are often referred to as private-REITs.
The fees associated with private-REITs are typically much more complicated than that of publicly-traded REIT ETFs. Here is a breakdown of the fees commonly collected by private-REITs.
An acquisition fee is typically 1% to 2% of the total deal size. These fees are used to cover the investment manager’s deal-finding expenses.
Private-REIT asset management fees can typically range from 1% to 2% of the total equity invested. The fund manager collects this fee to cover the expenses related to investment management services.
The administrative fee is used to cover expenses related to financial compliance such as tax reporting and audits. These fees are quite small and typically range from 0.1% to 0.2% of total equity invested. This fee is usually collected once per year.
Performance-based fees – also known as incentive fees – are a way of ensuring that the REIT’s financial performance is aligned with the interests of the investors. Typically, this fee consists of 20%-30% of the fund’s profits.
Other Private-REIT Fees
There are a variety of other fees charged by private-REITs. If you’d like to learn more, check out this great Introduction to Private Real Estate Investment Fees article from Origin Investments.
What Fees Mean For You (The Investor)
Fees can be the difference between a great investment and a terrible one, so it’s important to understand what you’re being charged. It’s also worth keeping in mind that all investment fees are relative and, in some cases, high-fees aren’t necessarily a bad thing. If an investment’s returns are consistently strong, then a high-fee might just come with the territory.
Take Renaissance Technologies for example. Renaissance is the world’s most successful hedge fund and it charges a 5% management fee and a 44% performance fee. The firm’s phenomenal track record allows them to charge this high-fee without upsetting investors. However, if an index fund charged a 5% management fee, then nobody would buy it. This is what we mean by investment fees are relative.
Fees are a critical component to understanding the true viability of an investment. We hope you found the information in this article useful and we encourage you to stay diligent around the subject of fees when building your own real estate portfolio.
Note that addy does not currently charge any fees. There are no transaction fees, no property acquisition fees, no withdrawal fees, no promotion fees, no lifts on the properties of any kind, nothing.
In the future, addy will charge a small annual fee to members. When that fee starts, a member’s existing investments will be grandfathered in.
Sign up for an addy account today to take advantage of addy’s 0% fee investment opportunities.