A real estate investment trust, or REIT (pronounced REET), is a company that owns a portfolio of commercial property or loans. In 1960, Congress established REITs to offer all investors, particularly small investors, the opportunity to earn money from rental properties. REITs combine the advantages of real estate and stock investing into one package.
This article will lead you through all the information you need about real estate investing with REITs, including the many types of REITs, their advantages and disadvantages, how to invest in REITs, and what makes a firm a REIT.
Types of Real estate investment trusts
REITs come in a variety of forms. Let’s start with dividing REITs by access:
Publicly traded REITs
Publicly traded REITs are one of the most well-known real estate investment trusts. They trade on major stock exchanges such as the NYSE and Nasdaq Market. Anyone with a brokerage account may invest in a publicly listed REIT. Publicly traded REITs must submit their audited financial statements to the U.S. Securities and Exchange Commission and provide audited financial reports.
Public non-traded REITs
Public non-traded REITs are open to any investors but do not trade on stock exchanges. These REITs are bought through the financial advice of a qualified professional or on real estate crowdfunding websites. They also are required to register with the SEC and submit audited financial statements.
Private non-traded REITs
Private non-traded REITs are not available to the general public. They’re usually only available to high-income individuals or high-net-worth individuals. Private non-traded REITs are not required to register with the SEC.
Within those REIT types are three subcategories based on asset type.:
Equity REITs are firms that own and operate income-producing real estate.
Mortgage REITs, or mREITs, are investment vehicles that buy and originate mortgages and mortgage-backed securities to profit from the interest payments on these assets.
Hybrid REITs invest in both income-producing real estate and real estate-backed loans.
Real estate investment trusts pros and cons
There are several advantages to investing in REITs, including:
- They often pay higher than average dividend yields in comparison to other equities.
- They offer a degree of diversification from the stock market.
- REITs can avoid “double taxation” by not paying federal corporate income tax.
- They provide appealing total return prospects, such as stock price appreciation and dividend income.
- REITs listed on a stock market offer greater liquidity than real estate directly.
- The transparency of public REITs is unrivaled, with audited financial reports available.
- Lower purchase price when compared to purchasing business real estate directly.
However, there are some drawbacks to buying into REITs:
- REITs are required to pay higher taxes since they distribute nonqualified dividends. As a result, REITs are frequently most effectively kept in a tax-advantaged account, such as an IRA.
- Sensitivity to interest rate changes
- Specific risks linked to your property, such as tenant move-outs, economic headwinds, and technological change
- The dangers of taking on too much debt.
How to invest in REITs
Many investors have several methods to invest in real estate investment trusts. First, they can buy publicly traded REIT shares through their brokerage account. An investor may purchase a diversified REIT or a portfolio consisting of several different REITs to diversify their holdings. Buying a mutual fund or exchange-traded fund (ETF) focused on REITs is another alternative for investors to invest in the broad sector. You can also invest in public non-traded REITs through a financial advisor or a real estate crowdfunding portal if you do not want to purchase individual shares of each company.
How to qualify as a REIT
To qualify as a REIT, companies must fulfill specific requirements and receive unique tax treatment, so they do not have to pay corporate income tax. These requirements include:
- A real estate investment trust (REIT) is a company that owns and develops real property. REITs are required to pay out a minimum of 90% of their taxable income as dividends to shareholders each year. Because cash flow, measured by funds from operations (FFO), is frequently higher than income owing to depreciation, many REITs pay out more than 100% of their taxable income.
- Create a company that would be subject to corporate taxes.
- A board of trustees or directors must manage them.
- Fully transferable shares are required.
- After its first year as a REIT, it must have at least 100 shareholders.
- During the last six months of its taxable year, five or fewer people may own no more than 50% of its shares.
- They must invest at least 75% of their assets in real estate property or cash.
- They must derive at least 75% of their gross income from real estate-related sources, such as rents from real property, interest on mortgages, financing real property, and the sale of real estate.
- A REIT must have at least 95% of its overall gross income from real estate sources and dividends or interest from any origin. In other words, 75% of the company’s total revenue must come from real estate, while only 5% can come from other sources such as dividends and interest.
- No greater than 25% of its assets can be in non-qualifying securities or stock in a taxable REIT subsidiary.
REITs can make great investments
Congress created REITs, so anybody might invest in real estate that produced income. As a result, they’ve become a fantastic source of dividend money. Include their diversification benefits and past performance, and REITs may be a great investment choice.