What Is a Real Estate Investment Trust?

In order to maintain an advantageous tax structure as a REIT, these companies must meet certain qualifications annually. REITs allow people to easily invest in various facets of the real estate sector without having to find, acquire, manage, and finance real estateReal EstateAt its most basic principle, Real Estate can be defined as properties that comprise land and its tangible attachments. The land includes the actual surface of the earth and any permanent natural objects such as water, dirt, or rock and any minerals or particulars under the surface. read more. They can also operate a wide array of real estate properties.

Key Takeaways

  • REITs are (typically) publicly traded companies that own and operate real estate.REITs allow investors to put capital into real estate without the large upfront investment and operations to acquire an entire asset.In order to stay classified and taxed as a REIT, companies must pay attention to several guidelines including paying out a minimum of 90% of all income to shareholders in yearly dividends.REITs can be a strategic asset to diversify an investor’s portfolio as they provide a regular income stream and also perform inversely to trade stocks.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Real Estate Investment Trust (REIT) (wallstreetmojo.com)

How do REITs Work?

Real estate investment trusts operate very similarly to real estate owners, operators, and lenders held by private equity and other groups. Equity REITs acquire and operate assets, generate revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more, and strategically sell assets. Mortgage REITs invest in mortgages and other debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more products and generate income from payments borrowers make. The difference is that REITs create funds either through private investors or in a public IPO.

Real estate is typically an illiquidIlliquidIlliquid refers to an asset that cannot be converted to cash. Such assets suffer a valuation loss when sold in exchange for cash. Bonds, stocks and properties are some examples of illiquid investment.read more investment because we need to hold the property for years in order to see major returns due to appreciation. We also likely need to have a large sum of capital to acquire and potentially renovate an asset. Publicly traded REITs are able to solve both of these problems: shares in a REIT are traded on the stock market and are now liquid, and we can invest as much or as little as we like in shares.

Companies with REIT status pay zero corporate taxCorporate TaxCorporate tax is a tax levied by the government on the profits earned by a company at a fixed rate each year and is calculated in accordance with specific tax regulations.read more. In order to qualify as a REIT, a company must operate under and maintain the following principles on a yearly basis:

  • It must invest 75% of total assetsTotal AssetsTotal Assets is the sum of a company’s current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equityread more in real estateA minimum of 75% of its gross incomeGross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity.read more must come from rental income, mortgage interest income, or real estate dispositionsA minimum of 90% of its taxable income must be annual shareholder dividends (most pay 100%)Must be taxed as a corporationMust have a board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals.
  • read more or trusteesA minimum of 100 shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more5 or fewer individuals/entities can own no more than 50% of its total shares

Types of REITs

The five types of REITs are:

  • Equity REITs: These are the most common REITs,  allowing people to invest in a variety of real estate properties types such as offices, apartments, warehouses, retail, medical facilities, data centers, cell towers, infrastructure, and timberland, self-storage, hospitality, specialty, etc.Mortgage REITs (or mREITs): Publicly held companies that purchase and originate mortgages/debt products and earn income through the difference between interests and cost of financing.Hybrid REITs: Companies with a blend of assets and mortgages in their portfolioPublic Non-listed REITs: REITs that are registered with the SEC but not traded on national exchangesPrivate REITs: REITs with private investors and not traded on national exchanges or registered with SEC.

Example of a REIT

Collectively, REITs own over $3 trillion in gross assets of more than 500,000 properties across the US and have a market capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more of over $1 trillion. Here are a few examples of REITs:

  • Simon Property Group (retail: SPG): One of the largest retail REITs and the largest shopping mall operator in the USCrown Castle International Corp. (telecommunications: CCI): Communications infrastructure provider with over 40,000 cell towers and 80,000 miles+ of fiber in the USPrologis (industrial: PLD): Investor in logistics facilitiesInvesco Mortgage Capital Inc (mortgage: IVR): Mortgage REIT that manages residential and commercial mortgage-backed securitiesMortgage-backed SecuritiesA mortgage-backed security (MBS) is a financial instrument backed by collateral in the form of a bundle of mortgage loans. The investors are benefitted from periodic payment encompassing a specific percentage of interest and principle. However, they also face several risks like default and prepayment risks.read more

How to Invest/Buy REITs?

A person can invest in REITs in a variety of ways. They can buy shares listed on major stock exchanges, just like Peloton or Tesla. They can purchase shares in a REIT mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more or exchange-traded fund (ETF). A broker or financial planner can also help them analyze various REITs that suit their investment objectives.

As of today, the National Association of Real Estate Investment Trusts (NAREIT) reports that up to 145 million Americans have funds invested in REITs through their direct investments or retirement savings. Beyond consumers investing with REITs, institutional investors like pension funds, endowments, and insurance companies also invest in REITs.

Advantages of REITs

  • REITs tend to provide high dividends from rental income as well as potential long-term capital appreciation.Capital Appreciation.Capital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.read more Over the long term, REIT stock returns are similar to value stocksValue StocksValue Stock is one that has the potential of selling at a higher price but due to the company’s adverse condition in the market, the stock is trading at a lower price than its actual worth based on its earnings, dividend, or sales.read more and produce greater returns than lower-risk bonds.REITs are useful for retirees and those saving for retirement because of the continuing income stream in the form of dividends which are at least 90 percent of the REITs’ taxable income annually.REITs also tend to perform in an inverse relationship to other equities and fixed-income investments, which makes them a good portfolio diversifier and can help with overall volatility in a given portfolio. For example, multifamily operators were seeing rent collection rates of over 90-95% during March-August 2020, whereas entertainment and live events companies’ income plummeted in the same period due to changes from the COVID-19 pandemic.

Disadvantages of REITs

  • Real estate companies that are not REITs take income from the asset in years 1 and 2 and reinvest it into the asset through various capital projects and renovations. Since REITs have to pay out a minimum of 90% of their income, they have little capital to funnel back into the asset.Typically, the federal government taxes dividends at a lower rate than ordinary incomeOrdinary IncomeOrdinary income refers to an individual’s or business entity’s earnings that are taxable at the regular rates. Such earnings include salary, wages, rent received, royalty, commission, interest received, profit, etc. It excludes all incomes with tax deducted at source and capital gain.read more. However, dividends from REIT holdings are defined and taxed as ordinary income. This can mean REIT dividends are getting taxed by 35%+ as compared to a maximum tax of 15% with the current dividend tax.

This has been a guide to Real Estate Investment Trust (REIT). We explain how to buy/invest in REITs along with its types, examples, advantages and disadvantages. You may also have a look at the following articles to learn more –

Real estate investment trusts are companies that manage and operate real estate properties that generate income. Investors can utilize these trusts to invest in real estate properties and gain profit in the form of dividends.

Real estate investment trusts pool money from investors and uses it to invest in income-generating assets like office spaces, warehouses, apartments, etc. The money that is generated through these real estate properties through various means is then distributed among the investors.

A company needs to meet a diverse set of rules to be declared as a real estate investment trust (REIT). To start a REIT, the company must decide on the type of REIT it chooses to be. It must have a minimum of 100 investors to be qualified as a REIT. The company has to file necessary forms to the IRS and fulfill the other set of compliances. 

  • Real Estate InvestingReal Estate AppraiserReal Estate Valuation