REIT or real estate investment trust is a type of investment vehicle that allows individuals to invest in real estate or related assets with an intention to earn income. REITs are similar to mutual funds. Like mutual funds channelize investors money in the stock market, in the same way, REIT’s give investors an opportunity to invest in real estate. This means that investors get a chance to invest and earn from valuable properties without actually owning it.
REIT owns or operates the income-producing properties, such as shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, mortgages or loans, office buildings and more. Unlike the real estate companies, REIT does not develop a real estate property with an intention to resell it. Instead, such income-producing properties are a part of its investment portfolio.
Majority of REIT or real estate investment trusts follow a simple business model. They lease a property, collect rent on it, and then distribute the profit as dividend among the shareholders. It is usually mandatory for REITs to pay at least 90% of their income to the shareholders.
Features of REITs
To qualify as a REIT, a company needs to meet a number of requirements. Most of the REITs trade on major stock exchanges. To qualify as a REIT a company must:
- Invest a minimum of 75% of its total assets in real estate.
- Earn a minimum of 75% of gross income in the form of rents, sales of real estate, or interest on mortgages financing a real property.
- Distribute a minimum of 90% of its taxable income among the shareholders as dividends annually.
- Have at least 100 shareholders.
- Board of directors or trustees must manage it.
- Must be taxable as a corporation.
Types of REIT or Real Estate Investment Trust
Most of the REITs deal with a specific real estate sector, for instance, there are healthcare REITs, office REITs and more. There are also diversified and specialty REITs that may invest in several real estate sectors, such as office and retail properties. Following are the types of REITs:
It is the most common type of REIT. Such REITs invest in properties and their income is primarily in the form of rent that is then distributed to the shareholders as dividends.
Such REIT or real estate investment trust generate their income from mortgages, i.e., by buying existing mortgage-backed securities or borrowing to the real estate owners. Their income is the difference between the interest on mortgage loans and the cost of funding these loans. Owing to their business model, these REITs are prone to interest rate risks.
Such REITs earn income from rent, as well as, from mortgage-backed securities and loans to the real estate owners.
Public Non-listed REITs (PNLR)
Such REITs are registered with the SEC but don’t trade on the stock exchanges.
Such REITs don’t need to register with the SEC and they also don’t trade on the national stock exchanges.
Benefits of Investing in REITs
- REITs trade on the stock exchanges, and thus, operate under the same rules as any public company. This ensures transparency.
- One can easily buy and sell shares of REITs. This ensures liquidity.
- Investors in REITs can expect a decent income as at least 90% of their profits are given to investors. Moreover, REITs are known to perform well due to steady long-term appreciation in the price of the properties.
- Investing in REIT allow an investor to diversify their portfolio. REITs usually have a low correlation with other asset classes.
Drawbacks of Investing in REITs
- REITs have limited growth opportunities as 90% or more of their profits are distributed among the shareholders, with only 10% or less remaining for reinvestment in the business.
- Dividends from REITs are taxed as usual dividend and are not subjected to a reduced tax rate as on some types of corporate dividends.
- REITs performance depends on the real estate market. Thus common factors that affect the real estate market, such as interest rates, property valuation, tax laws and more affect the performance of REITs as well.
- Some REITs charge high transaction and administrative fees from the investors. This lowers their net return.
REIT vs. Real Estate Fund
Both REIT or real estate investment trust and real estate fund are useful in diversifying investors’ long-term investment portfolio. A real estate fund mainly focuses on investing in the securities issued by the by public real estate companies. REIT’s, on the other hand, directly invest in an income-producing real estate asset. Unlike real estate fund, REIT does not invest in a real estate with an intention to resell, instead to continue earning income from it.
How to Invest in REITs?
One can invest in a REIT or real estate investment trust by buying shares via a broker. To invest in a non-traded REIT, one either needs a broker or a financial advisor who participates in the offering from the non-traded REIT. One can also buy a REIT mutual fund or REIT exchange-traded fund. Moreover, there are also options to invest in REITs through investment plans such as retirement savings and other investment funds.
There are over 200 REITs in the US. To choose the best to invest in, one must study REIT’s management team and track record. One can check the SEC’s EDGAR system to verify the authenticity of both publicly and non-traded REITs.