What is a REIT? Real estate investment trusts explained
Whether you’re new to investing, or a seasoned accredited investor, you may at some point have wondered, “What exactly is a REIT?” A REIT, or a real estate investment trust, is an organization that owns and operates income-generating real estate. There are a variety of commercial and residential properties that fall under the REIT umbrella, including apartment or condominium buildings, shopping centers, hotels, industrial warehouses, and even hospitals.
REITs in the United States own approximately $3 trillion of gross real estate assets. In 2017, public listed equity REIT portfolios included more than 500,000 properties. In addition to funding the real estate where many of us work and play (think amusement parks or casinos), and even where some of us live (condominiums), REITs also contribute $140.4 billion of labor income and provide 2.3 million full-time jobs, as outlined in EY data commissioned by Nareit.
What exactly is a REIT?
Quite simply, REITs enable investors to access diversified pools of income-producing real estate that they would otherwise not be able to access on their own, due to the amount of liquid capital required.
Real estate investment trusts were established under the Eisenhower administration in 1960 to give investors the ability to put money into income-producing real estate through the purchase of securities. This helped provide investors with the opportunity to have diversified, dividend-producing portfolios. Under this business model, a REIT leases out real estate and collects rent on the properties. The rental income is then distributed to shareholders in the form of dividends.
In order to qualify as a REIT, there are certain Internal Revenue Code rules that a company must be in compliance with, and certain requirements that must be met. Including (but not always limited to):
- A minimum of 75% of a company’s total assets must be invested in real estate, U.S. Treasuries or cash.
- 75% of the company’s income must be sourced from property rents, mortgage interest, or real estate sales.
- A minimum of 90% of the company’s taxable income must be returned to shareholders each year in the form of dividends.
- The REIT needs to be managed by a board of directors or trustees.
Who are REITs good for?
Now that you can answer the question of what is a REIT?, let’s take a look at what kind of investors could benefit from them. REITs can provide a great way for certain individuals to take advantage of real estate investing without having to actually purchase a property. They may also be an option for an investor that doesn’t feel comfortable assessing and vetting the risks of a real estate investment on their own. REITs allow investors to gain access to income-generating properties while having the peace-of-mind that their investment is managed by an experienced real estate investor.
Are there different types of REITs?
In addition to learning what a REIT is, you need to be familiar with the different types of REITs. REITs come in a variety of classifications that are based on both business type and how shares are transacted. REITs are either Publicly Traded REITs, Public Non-traded REITs, or Private REITs. Here’s a quick overview of each type of REIT:
Publicly Traded REITs issue shares that are listed on a national securities exchange. This form of REIT is regulated by the U.S. Securities and Exchange Commission (SEC) and shares are bought and sold by individual investors.
Public Non-traded REITs are not traded on the stock exchange, but are registered with the SEC. As they are not impacted by market fluctuations, they tend to be more stable than publicly-traded REITs. They do, however, have lower liquidity.
Private REITs, or private placement REITs are only available to an exclusive group of investors, are not publicly traded, and do not need to be registered with the SEC. These types of REITs are generally not liquid.
How REITs invest
In addition to there being different types of REITs, there are also different structures through which REITs invest. Each of the above REITs has a corresponding structure through which they invest. Let’s take a look at those options:
Equity REITs are the most common type of REITs. Under this model, revenue is driven through rent and not from the resale of properties within the portfolio. These REITs typically own the properties themselves and generate income from these properties. These REITs benefit from increasing real estate values.
Mortgage REITs (mREITs) provide money to real estate operators either directly through mortgages or through the acquisition of mortgage-backed securities (MBS). These types of REITs provide mortgages on real properties, are impacted by interest rate increases, and as a result, are more susceptible to outside factors than some of the other REIT classifications.
Hybrid REITs offer more diverse portfolios as they hold both physical rental properties and mortgage loans.
What are some of the pros and cons of investing in REITs?
As with any investment, it’s important to do your research to ensure that the benefits outweigh potential risks and that it ultimately aligns with your financial goals. Real estate investment trusts provide an alternative means to investing in real estate assets, whether publicly traded or not.
There are many advantages to this type of investment, including low minimums, high dividend yields, and mandatory investor distributions. However, it’s important for investors to understand both the pros and cons of REITs.
A few drawbacks to REITs include: overhead fees that impact profitability, sensitivity to market fluctuation and interest rates, and the complexity of the asset pool which often takes advantage of leverage, all which make understanding the risk complex.
Depending on the type of REIT, there are varying advantages and disadvantages. For instance, when it comes to sharing value transparently, publicly-traded REITs have market values that are readily available. However, if the REIT is non-traded, the estimated value per share may not be available until 18-months after an offering closes.
When it comes to taxes, shareholders are responsible for paying taxes on dividends and capital gains that result from their investment in the REIT. The dividends are viewed as regular income and do not receive reduced tax rates—some investors may benefit from the 20% QBI deduction.
How do I invest in REITs?
Real estate can be a great way to help build wealth and REITs provide a means to diversify investment portfolios while at the same time potentially earning higher returns. It has typically been an arena only available to well-connected investors with a ton of capital. Fortunately, REITs make it far easier for individual investors to participate and are available in several forms, including mutual funds, crowdfunding platforms, and exchange-traded funds (ETFs). As a result, it is relatively easy for an investor to get started, regardless of their portfolio size.
To jumpstart your portfolio diversification, you can invest in a publicly-traded REIT listed on the stock exchange by acquiring shares through your broker. If you are looking for non-traded REITs, you will need to leverage a broker or financial advisor that participates in this specific type of offering.
To avoid fraud, we suggest utilizing the SEC’s EDGAR system to verify the registration of both publicly traded and non-traded REITs. Before you invest, be sure to review the REIT prospectus to gain a better understanding of the associated risks and fees. Publicly-traded REITs will also have disclosure filings, annual reports, and quarterly reports available for your review in addition to prospectus information on the EDGAR database.
Capitalizing on REITs
REITs provide an avenue for you as an individual investor to help diversify your portfolio and profit from income produced through commercial real estate without the headache of actually purchasing the property yourself. As outlined above, there are several types of REITs available and it’s important to do your due diligence or consult with your financial advisor to understand the option that is best for you and your financial goals.
This communication and the information contained in this article are provided for general informational purposes only and should neither be construed nor intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Any link to a third-party website (or article contained therein) is not an endorsement, authorization or representation of our affiliation with that third party (or article). We do not exercise control over third-party websites, and we are not responsible or liable for the accuracy, legality, appropriateness or any other aspect of such website (or article contained therein).
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