What Are REITs?

REITs (Real Estate Investment Trusts) pool the money of many investors to invest in Real Estate.

Properties in a REIT portfolio can range from apartment complexes, and hotels to cell towers, and energy pipelines.

To legally qualify as a REIT in the United States, some of the criteria that need to be met include:

• At least 75% of total assets must be invested in real estate, cash, or U.S. Treasuries
• At least 75% of gross income must come from rents, interest on mortgages that finance real property, or real estate sales
• A minimum of 90% of taxable income must be paid to shareholders in dividends each year

Many REITs are publicly traded and therefore enable a uniquely liquid exposure to the Real Estate Market.

Types of REITs

Equity REITs

Equity REITs own and manage properties. They are the most common type of REIT.

Equity REITs primarily make money through collecting rent and trading properties.

Mortgage REITs

Mortgage REITs borrow cash at short-term interest rates to purchase mortgages that pay higher long-term interest rates. The profit for the REIT is the difference between the two interest rates.

Example of how a Mortgage REIT makes money:

Let's say a Mortgage REIT raised $1 Million dollars.

It then borrows $5 Million dollars at 2% interest.

It can then use this money to buy $6 million in mortgage debt at an interest rate of 4%.

Mortgage REIT Profit = ($6 million X 4%) - ($5 million X 2%)

Are REITs Halal?

Allah SWT says about Riba the following :

يَا أَيُّهَا الَّذِينَ آمَنُواْ اتَّقُواْ اللَّهَ وَذَرُواْ مَا بَقِيَ مِنَ الرِّبَا إِن كُنتُم مُّؤْمِنِينَ

فَإِن لَّمْ تَفْعَلُواْ فَأْذَنُواْ بِحَرْبٍ مِّنَ اللَّهِ وَرَسُولِهِ وَإِن تُبْتُمْ فَلَكُمْ رُؤُوسُ أَمْوَالِكُمْ لاَ تَظْلِمُونَ وَلاَ تُظْلَمُونَ

O you who believe, fear Allah and give up what remains [due to you] of riba, if you are in truth believers.

And if you do not, then be warned of war [against you] from Allah and His Messenger. But if you repent, you may have your principal – [thus] you do no wrong, nor are you wronged.

The Holy Quran, Surat Al-baqara, verses 278-279

For those who are unfamiliar with what Riba is, Riba is defined as: 

Any promise of benefit the lender receives in return for lending.

Accordingly, interest on debt fits the definition of Riba and is therefore haram in Islam.

So we want to avoid investing in things wherein the business of this thing is reliant on interest.

In the case of Mortgage REITs where the business is simply profiting from the difference in interest rates between short and long term debt, their business is definitely reliant on interest and therefore haram to invest in in my view.

The tougher question relates to Equity REITs. 

As we saw earlier, Equity REITs primarily make their money through collecting rent and trading in properties.

There is nothing wrong, from an Islamic perspective, with either of these activities. 

The question that needs to be answered however is how reliant are Equity REITs on interest in their operations?

To finance the purchase or construction of properties, REITs can turn to three possible sources of funds:

1. Internally generated cash. This source is unlikely since as we saw earlier, by law, REITs must distribute 90% of their income to their investors. This leaves only 10% of income to be reinvested.
2. Equity. This entails going back to the markets and trying to raise more money from investors. The challenge for a REITs management in this case is how to raise money in a way that doesn’t anger current shareholders by diluting their shares. 
3. Debt. REIT managers prefer to avoid the negative reaction to new equity issuance and resort to debt instead.

This preference for debt shows up in the numbers.

If you look at the coverage ratio which compares earnings to interest expense in Q1 of 2020 for publicly traded U.S. equity REITs that number is at 4.6X, so interest expense was close to 21% of operating income.

This elevated amount of interest expense causes me to believe that even Equity REITs are reliant on dealing with interest in order to operate. This makes me uncomfortable investing in them from a halal-ness standpoint.

To the extent one can find an Equity REIT that is not reliant on interest to operate, my comfort level in investing would increase since there is nothing inherently wrong with making money from leasing or trading property.