A real estate investment trust (REIT) is a company that buys, develops, manages, and/or sells real estate such as skyscrapers, shopping malls, apartment complexes, office buildings, or housing developments. Rather than investing directly in real estate, investors of REITs invest in a professionally managed portfolio of real estate. REITs trade on the major exchanges, just like stocks. REITs make money from rental income, profits from the sale of the property, and other services provided to tenants. REITs also receive special tax considerations; they do not pay taxes as long as they pay out at least 90 percent of their net income to their investors. Thus, successful REITs can offer investors high yields, current income, and moderate growth.
There are several types of REITs. An equity REIT’s main business is buying, renovating, managing, maintaining, and selling real estate. This is by far the most common type of REIT available today. Mortgage REITs make loans or invest in existing mortgages. Hybrid REITs combine the characteristics of equity and mortgage REITs. Additional corporate structures (e.g., the UPREIT and Down- REIT) were developed in the early 1990s; these REITs typically focus on providing tax benefits to their shareholders. What are the strengths?
All REITs are governed by strict regulations. REITs are generally required to have at least 100 investors, and there are laws that prevent a small number of those investors from owning a majority interest in the REIT. At least 75 percent of a REIT’s assets must be in real estate, and at least 75 percent of its gross income must be derived from rents, mortgage interest, or gains from the sale of property. Also, REITs are required by law to pay out at least 90 percent of annual taxable income (excluding capital gains) to their investors in the form of dividends. This restriction, however, limits a REIT’s ability to use internal cash flow for growth purposes. REIT shares are more liquid than investing directly in real estate
If you need cash in a hurry, it is much easier to liquidate shares of a REIT than it is to sell rental property, office buildings, or other real estate. Part of the reason for this liquidity is that REIT shares are typically traded on major exchanges, making it easier to buy and sell REIT shares than to buy and sell properties in the private market. Professional management
REITs are run by professionals. Once you have purchased shares in a REIT, your investment is in the hands of people who make their living by buying, selling, and managing real estate. You don’t have to be an expert real estate trader, because the professionals are making the decisions for you. REITs open up investment opportunities that might not be available to individual investors
Because you are pooling your money with the funds of many other investors, your initial cash outlay is much less than for other types of real estate investments. This makes REIT investing accessible for many people who can’t afford to buy office buildings and apartments on their own. And because your money is pooled with that of other investors, your personal exposure to risk is lower than if you were investing directly in real estate. REITs can provide current income
Because REITs are required to pay out 90 percent of their annual income in the form of dividends, you can expect to receive income from your REIT investment. Many are currently 6-8% annual dividends What are the tradeoffs? Supply/demand imbalance
REITs depend on an adequate supply of tenants and/or buyers to occupy their properties. During certain periods (e.g., a building boom), the supply of available space may exceed the demand by a significant margin, leaving REITs with property that is vacant or less than fully occupied. During these periods, it may also be difficult to make profits on rents because the excess supply of rental property will drive rental prices down. These factors can negatively impact a REIT’s profitability.
This information is educational in nature and is being provided with the understanding that it is not intended to be interpreted as specific legal or tax advice. Individuals are encouraged to consult with a professional in regards to legal, tax, and/or investment issues.