Joining A Real Estate Investment Trust: A Beginner's Guide

Real estate investment trusts (REITs) are companies that own, operate, or finance income-producing real estate. They were created in 1960 to allow investors to invest in commercial real estate without having to buy and manage properties themselves.

REITs are required to meet certain standards set by the IRS, including distributing at least 90% of their taxable income to investors as dividends. They are typically categorised into commercial REITs (C-REITs) and residential REITs (R-REITs).

There are several types of REITs, including equity REITs, mortgage REITs, and hybrid REITs. Most REITs are publicly traded on major exchanges, but there are also public non-listed and private REITs.

To join a REIT, an individual can buy shares in a REIT listed on a major stock exchange, just like any other public stock. Investors can also purchase shares in a REIT mutual fund or exchange-traded fund (ETF).

REIT requirements

To qualify as a Real Estate Investment Trust (REIT), a company must meet several requirements, including:

• Organizational requirements: A REIT must be structured as a corporation, trust, or association, governed by a board of directors or trustees, and have transferable shares. It must be formed in one of the 50 US states or the District of Columbia and be taxable as a corporation. Additionally, REITs must have a minimum of 100 shareholders and ensure that no more than 50% of their shares are held by five or fewer individuals (known as the 5/50 Test).
• Operational requirements: REITs must satisfy annual income tests and quarterly asset tests to ensure that the majority of their income and assets are derived from real estate sources. Specifically, at least 75% of their annual gross income must come from real estate-related sources, such as rents and mortgages on real property.
• Distribution requirements: To qualify as a REIT, a company must distribute at least 90% of its taxable income to shareholders as dividends.
• Compliance requirements: To become a REIT, a company must make a REIT election by filing an income tax return (Form 1120-REIT) and meet various REIT tests. They must also comply with specific rules, such as mailing annual letters to shareholders requesting details of beneficial ownership.

These requirements are set by regulatory bodies like the Internal Revenue Service (IRS) in the United States and are designed to ensure that REITs operate within certain guidelines and provide investors with a regulated investment opportunity in real estate.

REIT types

Real Estate Investment Trusts (REITs) are typically categorised into two main types: equity REITs and mortgage REITs (mREITs). However, there are also hybrid REITs, which combine elements of both equity and mortgage REITs.

Equity REITs

Equity REITs operate like a landlord, handling all the management tasks associated with owning a property. They own the underlying real estate, collect rent, provide upkeep, and reinvest in the property. They generate income through the collection of rent and from sales of the properties they own for the long term.

Mortgage REITs (mREITs)

Mortgage REITs do not own the underlying property. Instead, they own debt securities backed by the property. For example, when a family takes out a mortgage on a house, this type of REIT might buy that mortgage and collect the monthly payments, generating revenue through interest income.

Hybrid REITs

Hybrid REITs own and operate real estate properties and also own commercial property mortgages in their portfolio.

Publicly Traded REITs

Publicly traded REITs are traded on an exchange like stocks and are available for purchase using an ordinary brokerage account. They tend to have better governance standards and be more transparent, and they offer the most liquid stock.

Public Non-Traded REITs

Public non-traded REITs are registered with the SEC but are not available on an exchange. They can be purchased from a broker that participates in public non-traded offerings and tend to be highly illiquid.

Private REITs

Private REITs are not listed and are generally exempt from SEC registration, making their performance harder to evaluate. They are also harder to value and trade and are usually only available to institutional investors.

REIT benefits

Joining a real estate investment trust (REIT) can be done by opening a brokerage account and purchasing shares in a REIT, similar to buying stocks. REITs are companies that own, operate, or finance income-producing real estate, and they offer a range of benefits to investors. Here are 4-6 paragraphs detailing the advantages of investing in REITs:

High Dividend Income and Competitive Returns

REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends, resulting in steady and attractive dividend yields for investors. This high dividend income, combined with long-term capital appreciation, has historically provided competitive total returns for REIT investors.

Portfolio Diversification

REITs are an excellent tool for diversifying an investment portfolio due to their low correlation with other assets. Including REITs in a portfolio can help reduce overall risk and increase returns by providing exposure to a range of property sectors, such as apartment buildings, offices, retail centers, and warehouses.

Liquidity

Most REITs are publicly traded on major stock exchanges, making them highly liquid investments. This means that investors can easily buy and sell REIT shares, providing flexibility and accessibility not typically associated with traditional real estate investments.

Transparency and Ease of Investment

REITs offer the benefits of real estate investment with the transparency and ease of investing in publicly traded stocks. They provide a straightforward and understandable business model, making it simpler for investors to evaluate and compare different REIT options.

Inflation Protection

Over time, REITs have demonstrated the ability to protect investors against inflation. The income generated by REITs, derived from rents or interest payments, tends to increase with inflation, providing a hedge against rising prices.

Tax Benefits

In some countries, REITs provide tax advantages for investors. For example, in the United States, REITs are exempt from corporate income tax as long as they distribute at least 90% of their taxable income to shareholders as dividends. This pass-through structure can result in higher dividend yields for investors and tax-efficient investing.

Overall, REITs offer a range of benefits that make them an attractive investment option for those seeking exposure to the real estate market while enjoying the advantages of a publicly traded security.

REIT drawbacks

Joining a real estate investment trust fund (REIT) is a way for investors to buy shares of companies that own and operate income-generating properties. REITs are typically publicly traded or non-traded, with different risks and trading options.

Tax Implications

REIT dividends are typically taxed as ordinary income, which is often at a higher rate than other investments. REIT investors may incur a significant tax bill, especially if they have a large stake in the fund.

Interest Rate Sensitivity

REITs are sensitive to changes in interest rates, and rising interest rates can cause a decline in REIT stock prices. The value of REITs is often inversely tied to the Treasury yield.

Property-Specific Risks

REITs tend to specialize in specific property types, such as office buildings, apartment buildings, or retail spaces. Investors need to consider the risks associated with these property types, such as tenant move-outs, industry headwinds, or changes in demand.

Fees and Commissions

Non-traded REITs may have high upfront fees, sales commissions, and annual management fees. These fees can eat into the overall returns that investors realize.

Market Volatility

REITs are subject to market volatility, especially due to interest rate movements and trends in the real estate market.

Limited Control

While REITs provide an opportunity to invest in real estate without directly managing properties, they also come with less control over the investment.

Before investing in a REIT, it is essential to carefully consider these potential drawbacks and conduct thorough research to ensure it aligns with your investment objectives and risk tolerance.

How to invest in REITs

REITs, or Real Estate Investment Trusts, are companies that own or finance income-producing real estate across a range of property sectors. They are traded on major stock exchanges, and they offer a number of benefits to investors.

There are several ways to invest in REITs:

• Purchasing shares of publicly traded REIT stocks
• Mutual funds
• Exchange-traded funds
• Public non-listed REITs
• Private REITs

How to Get Started

To get started, you will need to open a brokerage account or investment account. You will then be able to buy and sell publicly traded REITs as you would with any other stock.

Tips for Choosing a REIT

• Steady dividends: REITs are required to pay out at least 90% of their annual income as shareholder dividends, so they offer some of the highest dividend yields on the market.
• High returns: REITs can offer higher returns than equity indexes, making them an attractive option for portfolio diversification.
• Liquidity: Publicly traded REITs are easier to buy and sell than the process of buying, managing and selling commercial properties.
• Lower volatility: REITs tend to be less volatile than traditional stocks, making them a good hedge against market ups and downs.
• Heavy debt: REITs are among the most indebted companies in the market, but investors have accepted this due to the regular cash flow that supports debt payments and ensures dividends.
• Low growth and capital appreciation: REITs pay out a large proportion of their profits as dividends, so they may not be able to buy new real estate when they want to.
• Tax burden: While REIT companies pay no taxes, investors must pay taxes on dividends received.

REIT Categories

There are three broad categories of REITs:

• Equity REITs: These operate like a landlord, handling all the management tasks associated with owning a property.
• Mortgage REITs: These own debt securities backed by property, such as mortgages on family homes.
• Hybrid REITs: A combination of equity and mortgage REITs, these businesses own and operate real estate properties and also own commercial property mortgages.

REIT Pros and Cons

Pros

• High-yield dividends
• Portfolio diversification

Cons

• Dividends are taxed as ordinary income
• Sensitivity to interest rates
• Risks associated with specific properties

Frequently asked questions