Real Estate Investment Trust (REIT)

Updated on April 17, 2024
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Real Estate Investment Trust?

A Real Estate Investment Trust (REIT) is a company that owns and operates real estate properties. Typically REITs are public companies and allow consumers to trade shares in real estate on major stock exchanges. There are five types of REITs: equity, mortgage, hybrid, private, and publicly non-listed.

What Is A Real Estate Investment Trust

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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 estate. 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.

Real Estate Investment Trust Explained

The real estate investment trust is a kind of trust or a company that performs its business operations through ownership or funding of properties It is a very unique way in which small investors get the opportunity to put their money in this sector in small amount and earn decent income in the form of dividends. It has gained huge popularity globally. However, the process is subject to some rules and regulations.

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 revenue, and strategically sell assets. Mortgage REITs invest in mortgages and other debt 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 illiquid 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 real estate investment trust stocks 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.

It is an attractive form of investment option because of the regular dividend income and small investment that is required for the same even though it s in real estate.  The funds are professionally managed and provides diversification in different forms of property in the market, with a lot of transparency and and liquidity.

This kind of investment can be in the form of field of mortgage or equity or hybrid form, as detailed in the article below. But they offer a good opportunity for investors to participate in the real estate market even though they have their own risk and rewards.

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Regulations

Companies with real estate investment trust stocks status pay zero corporate tax. 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 assets in real estate
  • A minimum of 75% of its gross income must come from rental income, mortgage interest income, or real estate dispositions
  • A minimum of 90% of its taxable income must be annual shareholder dividends (most pay 100%)
  • The top real estate investment trust must be taxed as a corporation
  • Must have a board of directors or trustees
  • A minimum of 100 shareholders
  • 5 or fewer individuals/entities can own no more than 50% of its total shares

RIET or Real Estate Investments Trusts- Explained in Video

 
 

Types

The five types of top real estate investment trust are:

  1. 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.
  2. 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.
  3. Hybrid REITs: Companies with a blend of assets and mortgages in their portfolio
  4. Public Non-listed REITs: REITs that are registered with the SEC but not traded on national exchanges
  5. Private REITs: REITs with private investors and not traded on national exchanges or registered with SEC.

Examples

Collectively, REITs own over $3 trillion in gross assets of more than 500,000 properties across the US and have a market capitalization of over $1 trillion. Here are a few examples of REITs:

  1. Simon Property Group (retail: SPG): One of the largest retail REITs and the largest shopping mall operator in the US
  2. Crown Castle International Corp. (telecommunications: CCI): Communications infrastructure provider with over 40,000 cell towers and 80,000 miles+ of fiber in the US
  3. Prologis (industrial: PLD): Investor in logistics facilities
  4. Invesco Mortgage Capital Inc (mortgage: IVR): Mortgage REIT that manages residential and commercial mortgage-backed securities.

How To Invest?

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 fund 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.

Tax Treatment

In order to invest in REIT, it is necessary to have knowledge about the taxation procedure also. So let us study about the same in details.

Any income that is received from investments in REIT can be in the form of either capital gains or any other ordinary income. is subject to some amount of tax. Generally this income is treated as ordinary income and is taxed as per the investor’s tax rate.

The REIT will intimate the investor about the portion of dividend that will be a capital loss or capital gain. Such situations will take place in case the trust sells any part of its property that it has been holding for minimum of a year. This amount is passed on to the investor, in which case the gains will be subject to taxation at either 0% or 15% or 20%, which will again depend on the income earned by the investor within the year when the gain has been received.

Advantages

There are some advantages and disadvantages of the real estate investment trust companies.

  • REITs tend to provide high dividends from rental income as well as potential long-term capital appreciation. Over the long term, REIT stock returns are similar to value stocks and produce greater real estate investment trust 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.
  • It is an easy form of investment opportunity for small investor who get access to invest in real estate and receive real estate investment trust returns. Otherwise participation in this sector becomes impossible due to large capital requirement.
  • Since the trusts are subject to strict regulations, it is obvious that there will be a lot of transparency and and investors can depend on them while taking inveyment decisions.
  • Since the investors do not have to track the movement in real estate hands-on, but at the same time invest in it, the opportunity saves a lot of time and provides financial gain without actually taking any responsibility related to ownership of property.
  • The investment trusts are managed by finance professionals who have the required skill and knowledge in the field. This provides assurance to investors that their money is in safe hands.
  • Since it is a relatively liquid investment, investors can frequently buy or sell them in stock exchanges, providing liquidity in the market.

Disadvantages

Some important disadvantages of the concept are as follows.

  • 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 income. However, dividends from real estate investment trust companies’ 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.
  • The investment is subject to market risk because the REIT share price fluctuates due to impact of property values or income from rent.
  • This process does not allow investors to directly invest in real estate.
  • Since the funds are invested only in properties of different types, the investment remains concentrated with the same sector, which does not provide diversification.
  • In the process, investors earn from dividend received from the trust, which will be less compared to earnings possible if money is invested in actual property.

Therefore, every investor who plans to put their money into this option must first analyze their own risk appetite, investment horizon, and goal of investing. Based on that and after gaining a proper understanding of the concept, they should buy the shares on REIT. It is always better to get professional help regarding the same.

Frequently Asked Questions (FAQs)

What are real estate investment trusts?

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.

How does a real estate investment trust work?

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.

How to start a real estate investment trust?

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.
 

This has been a guide to what is Real Estate Investment Trust (REIT). We explain how to invest, types, regulations, examples, tax treatment & advantages. You may also have a look at the following articles to learn more –

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