REITs – The Underrated Investment Vehicle

What exactly is a REIT? How does it operate? What are the advantages of a REIT structure?

These are the questions that investors and other interested parties may have since this type of investment is often overlooked when looking into investment options. However, a REIT, an acronym for Real Estate Investment Trust, can be a suitable fit for an investment portfolio when the investor is better informed of how it works and its potential benefits.

REITs Explained:

At its core, a REIT is a corporation, trust or association that purchases various types of real estate for income-producing purposes. This pool of real estate is carefully managed in order to produce income through renting, leasing, developing, and selling. The income is then distributed to the REIT owners in the form of dividends. However, companies must adhere to specific requirements to be considered a REIT. Some of these requirements include:

• At least 75% of total assets must be invested in real estate.
• At least 75% of gross income must originate from real estate sources.
• It must have a minimum of 100 shareholders, but 5 (or fewer) of these owners cannot own more than 50%.
• It must be taxed as a corporation.

How REITs Operate:

Although there are certain requirements to be followed, not all REITs are organized identically. The two main forms are – (1) Equity REITs and (2) Mortgage REITs. Equity REITs own and manage certain types of real estate within the organization. Properties such as hospitals, apartment complexes, malls, and residential homes can all qualify. REITs generate income through the collection of rent payments from tenants that lease the property, and can also have earnings from selling these assets. The majority of Equity REITs are publicly traded, but there are also some that are privately held, and ones that are publicly registered, but not listed.

In contrast, Mortgage REITs serve as the financial backing for other mortgages, rather than acquire physical properties. Income is produced from the interest on the mortgages that these REITs fund. However, mortgage REITs are highly susceptible to rapid and/or unpredictable changes in interest rates, so there is always a possibility of an unprofitable investment.

REIT Advantages:

There are three key benefits that can be realized through a REIT:

1. REITs offer the opportunity to invest in real estate without the significant financial burden and time commitment that typically comes with purchasing investment properties. Furthermore, diversification in investing is enhanced since REITs purchase various types of real estate. REIT ownership may also mitigate the problems and negative effects of owning a single property.
2. Owners have a direct interest in the real estate that the REIT manages. The value comes from the property’s appreciation in value over time, and the investors benefit from the rental income as well.
3. Arguably, the most well-known and important characteristic of REITs is the mandatory distribution of at least 90% of its taxable income to the owners. In many cases, all of the taxable income is paid out; therefore, the REIT seldom pays any taxes. In circumstances when some income is retained, the REIT is subject to the same taxation rules as corporations. Fortunately, the Tax Cut and Jobs Act of 2017 lowered the corporate income tax rate to 21%.

While this article only provides a high-level overview of REITs, it is a type of investment that investors should be aware of in order to make well-informed portfolio decisions. REITs provide investors a number of benefits including diversification, dividends, liquidity, performance, and transparency.

Author: Gabriela Cura | [email protected]