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What is a REIT?
A Real Estate Investment Trust, or REIT, is a company that combines the capital of many investors to enable small investors to make investments in real estate. Congress created REITs with the Real Estate Investment Trust Act of 1960 and has subsequently expanded their capabilities with several other pieces of legislation. One of the biggest advantages of the REIT structure is that REITs do not pay federal income tax at the corporate level, and many states provide similar tax treatment. To qualify for this treatment, REITs must meet a variety of requirements, one of the most attractive to investors being that they must distribute at least 90% of their taxable income to shareholders each year.
Why Invest in a REIT?
REITs are owned by a variety of investors, including individuals, pension funds, endowment funds, insurance companies, bank trust departments and mutual funds. These investors generally invest in a REIT for one or more of the following reasons, however this list is not exhaustive.
- Current income in the form of dividends
- Potential long-term stock appreciation
- Liquidity in a real estate investment
- Ability to leverage investments of multiple small investors
- One of the only ways for small investors to participate in the real estate market
Avantages of a REIT
There are several advantages to the REIT structure, many of which are listed below:
- A REIT must distribute at least 95% of its taxable income to stockholders
- A REIT does not pay federal, and in many cases state, taxes at the corporate level
- Investments in REITs are liquid and many REITS trade on national exchanges
- REITs allow investors to specialize or diversify their real estate investments
- Investors receive a 1099 reporting their income rather than a partnership K-1
- State taxes are only paid in the state where the investor resides
- The Shareholders elect an independent Board of Directors to oversee investments
- The Board of Directors utilizes professional management to operate the REIT
- REIT performance is monitored by independent directors, independent analysts, independent auditors and the media, and for public REITs, by the SEC
Types of REITs
There are three main classifications of REITs:
- Equity REITs that own real estate and collect rent
- Mortgage REITs that loan money to real estate owners and collect interest
- Hybrid REITs that combine the equity and mortgage REIT investment strategies
The other factors that typically distinguish REITs are:
- Type and variety of properties in which the REIT chooses to invest
- Geographic focus, whether it be regional, national or even international
REIT Requirements
To qualify as a REIT, a company must comply with various Internal Revenue Code regulations, including the following:
- Be a corporation, business trust or similar association
- Be managed by a board of directors or trustees
- Have shares that are fully transferable
- Have a minimum of 100 shareholders
- Have no more than 50 percent of shares held by five or fewer individuals
- Invest at least 75% of total assets in real estate assets
- Derive at least 75% of gross income from rents from or interest on real property
- Pay dividends of at least 90% of REIT taxable income
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