What are Retail REITs?
Retail REITs are a type of REIT that owns and manages retail properties in central business districts and upmarket areas. It leases the retail space to tenants looking to set up shopping malls, grocery stores, boutiques, etc. Retail REITs make money by leasing space to tenants, who pay monthly, quarterly, or annual rent to the REIT company.
Retail properties are attractive investments, and they are the single largest category of investments in the United States. When developing retail properties, most real estate properties focus on getting the strongest possible anchor tenant to become the first tenant in the building.
Anchor tenants are often associated with prestige. Name recognition is a major attraction to customers and tenants, which may be a department store, retail chain store, or an improvement store. A retail REIT can also purchase struggling retail properties such as shopping malls with the hope of turning them around and attracting desirable tenants who can meet their monthly rental obligations.
- Retail REITs own and manage retail properties that are leased to shopping malls, grocery stores, outlet centers, boutiques, etc.
- Retail REITs lease retail space to tenants who are required to pay a monthly rent and a share of the operating expenses in the property.
- Owning shares in retail REITs provides investors with an opportunity to earn high returns since the retail properties appreciate over time.
How Retail REITs Work
A retail property REIT business model focuses on developing, acquiring, managing, and owning retail property. The company can develop and manage the property through a team of experienced real estate managers and generate revenues for the company.
Sometimes, a retail REIT may also enter into a contract with other real estate companies to manage their portfolio of retail properties. The company will be in charge of finding new tenants and collecting rental income from the existing tenants on behalf of the owners. The retail REIT is then paid a percentage of the rental income, based on the initial agreement with the property owners.
All the rental incomes collected from properties owned by the REIT, commissions earned from managing other retail properties, and profits from the sale of retail properties are distributed to the investors. By law, REITs are required to distribute a majority of the net annuals to their shareholders as dividends. Also, three-quarters of the returns should be generated from real estate-related activities such as rent, sale of properties, and related transactions.
A retail REIT entity should also be structured like any other taxable corporate fully constituted of a board of directors/trustees, employees, and a constitution. Breaking any of the laws enacted by the US Congress will strip the retail REIT of some of the benefits enjoyed by REITs. One of the benefits is the exemption from corporate taxes and federal-level taxes. The revenue is only taxed at the shareholder level after distribution to shareholders, who are required to declare the income when filing taxes.
Types of Retail REITs
The following are the main types of retail REITs:
1. Shopping Mall Retail REITs
Shopping mall REITs, also known as mall REITs, are a great investment opportunity for investors looking for strong returns and above-average dividend yields. As the retail industry evolves, shopping mall REITs offer a greater potential for growth. Malls tend to lease their space on a long-term basis with periodic rent increases, which assures the investors continued revenues over the years.
Also, malls are tenant-diverse, and they can accommodate a high number of tenants at the same time. If one of the tenants shifts location, there will be a little effect on the revenues, and space can be filled up within a short time due to the high demand for mall space. Apart from rental income, shopping malls also make money from other services such as parking fees, swimming pools, conference halls, etc.
2. Freestanding Retail REITs
Freestanding retail REITs, also known as net lease REITs, offer rental space to tenants on a long-term basis. They lease space to tenants that offer a product or service that is needed on a regular basis, such as restaurants, theaters, fitness centers, pharmacies, and convenience stores. Such tenants are generally stable, and they lease the space for a long period, such as a 10-year lease or a 20-year lease.
The agreement signed between the tenants and the net lease REIT requires the tenants to pay the monthly rents, plus other expenses, such as insurance, maintenance costs, and taxes. Since the tenants are well-established in their industries, there is a low probability of such tenants defaulting on their monthly, quarterly, or annual obligations.
In addition, since these tenants cover most of the operating expenses, the REIT is protected from a surge in operating expenses, making the cash flows more predictable. The nature of free-standing retail REITs makes them an attractive investment opportunity to investors who are looking for a consistently high return on their investment.
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