What Are Real Estate Investment Trusts All About – And Why They Might Be For You
Investing In A REIT Is Participating In The Commercial Real Estate Investment World Without Actually Buying
Real Estate Investment Trusts or “REITs” are companies or corporations or other entities that owns, and most commonly operates a portfolio or income-producing real estate or real estate-related assets. REITs are designed for individual investors to earn portions or shares or fractions of the income produced through commercial real estate ownership. The beauty of which is the investor is not required to actually go out and purchase the commercial real estate themselves as others have already done that. REITs come in all categories and may include office buildings, shopping malls, resorts, apartments, self-storage facilities, hotels, warehouses, and mortgages or bundled mortgage loans.
REITs typically specialize in a single type of asset class. For example, apartment communities may be the focus of one REIT. There are REITs of all dimensions including retail, office, residential, healthcare and industrial as examples.
REITs are required to primarily hold and operate the properties that they develop. This distinguishes REITs from other real estate companies. Most real estate investors and developers are always looking at reselling the properties after they have been developed.
For the IRS to qualify a company as a REIT, a company must have the majority of its assets and income in real estate investments and must distribute a minimum of 90 percent of its taxable income to shareholders or members annually in the form of dividends.
A REIT shall have these qualifications as well:
- Must be an entity that would qualify as taxable corporation but for its REIT status;
- Must be actively managed by a board of directors or trustees;
- Must have shares or ownership interests that are fully transferable;
- Must have a minimum of 100 shareholders or members in year one (1) as a REIT;
- Must have no more than 50 percent of its shares held by five or fewer individuals during the last half of the taxable year;
- Must invest at least 75 percent of its assets in real estate and cash;
- Must derive at least 75 percent of its gross income from real estate related sources, including rents from investment property and interest on mortgages;
- Must have no more than 25 percent of its assets consist of non-qualifying securities or stock in taxable REIT subsidiaries.
Categories of REITs
REITs fall into three categories: Equity REITs, Mortgage REITs, and Hybrid REITs.
Most REITs are equity REITs. Equity REITs commonly own and operate all types of income-producing real estate (discussed above). These types of REITs are generally not as leveraged as mortgage REITs.
Mortgage REITs provide money to real estate owners and operators either directly in the form of mortgages or other types of real estate loans, or indirectly through the acquisition of mortgage-backed securities. Mortgage REITs tend to be more leveraged (using borrowed capital) than equity REITs. In addition, many mortgage REITs manage their interest rate and credit risks through the use of derivatives and other hedging techniques.
It is imperative that you understand the risks of these strategies before deciding to invest in these types of REITs. Standard brokerages offer REITs as investment tools in 401Ks, IRAs, brokerage accounts, and other investment accounts. Please take time to read the disclosures for the REIT you are interest in before actually investing.
Hybrid REITs are companies that use the investment strategies of both equity REITs and mortgage REITs.
The most stable and well-known REITs (whether equity or mortgage) are registered with the Securities and Exchange Commission and are publicly traded on a stock exchange (publicly traded REITs).
Additionally, some REITs are registered with the SEC, but are not publicly traded. These are known as non-traded REITs (also known as non-exchange traded REITs). An investor should understand the risks of the different types of REITs and their strategies before deciding to invest in them.
As with any investment, you should take into account your own financial situation and risk tolerance, consult your financial adviser, and perform thorough research before making any investment decisions concerning REITs. You can review a REIT’s disclosure filings, including annual and quarterly reports and any offering prospectus. You can invest in a publicly traded REIT, which is listed on a major stock exchange, by purchasing shares through a broker (as you would other publicly traded securities). Generally, you can purchase the common stock, preferred stock, or debt securities of a publicly traded REIT. You can purchase shares of a non-traded REIT through a broker that has been engaged to participate in the non-traded REIT’s offering. You can also purchase shares in a REIT mutual fund (either an index fund or actively managed fund) or REIT exchange-traded fund.
Investing in a REIT is participating in the commercial real estate investment world without having to go through all of the hoops and jumps of actually purchasing the investment properties. Please consider this approach to diversify your investment portfolio.
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