What Is A REIT?
A real estate investment trust (REIT) is a company that specializes in the purchase of cash-producing real estate assets. Many REITs are publicly-traded companies which allows individual investors to passively gain exposure to cash-producing real estate. Shareholders benefit from the law which requires REITs to distribute 90% of their taxable income to shareholders in the form of dividends.
REIT Requirements
There are many requirements that must be met in order for a company to qualify as a REIT. These requirements were laid out when the U.S. Congress established REITs under the Cigar Excise Tax Extension in 1960. The following list includes these requirements.
- Gain at least 95% of gross income from real estate or other dividend/interest paying sources
- May have no more than 25% of the companies assets may be in non-qualifying securities
- Must distribute at least 90% of income to shareholders annually
- Must have at-least 100 shareholders after 1 year.
- Gain at least 75% of gross income from real estate
- Must be managed by a board of directors
- Have no more than 50% of its shares owned by five or fewer individuals
- Must be taxable as a corporation
What Are The Different Types Of REITs?
There are three different types of REITS. These three are listed below.
- Mortgage REIT – Mortgage REITs hold mortgages on the underlying real properties
- Equity REIT – Equity REITs own manage income producing real estate assets
- Hybrid REIT – Hybrid REITs specialize in both property management and mortgage holdings
Investing In REITs
For investors looking to gain exposure to the real estate world, REITs offer a great opportunity. Any investor with a brokerage account possesses the ability to purchase shares of publicly traded REITs. Investors can also easily diversify their REIT holdings by investing in a mutual or exchange-traded fund which specializes in REIT investments. While it may be more difficult to do so, individual investors may also purchase “public non-traded REITs.” However, these companies trade with significantly less volume than typical REITs and thus, their shares are less liquid. Unfortunately, “Private REITs” are only available to institutional investors as they are not publicly traded or registered with the SEC.
Why Invest In REITs?
As stated before, REITS provide easy exposure to the real estate asset class. Of course, this exposure comes with the benefit of diversification to an investor’s portfolio. REITs are also beneficial to investors seeking cashflow-producing assets. Typically, REITs have greater dividend yields than other companies because of their requirement to distribute most of their capital. Of course, like any asset class, not all REITs should deserve an investment. Each REIT should be viewed as an individual company and be analyzed thoroughly.
Limitations To REIT Investments
There is no perfect asset class, REITs are not an exception. One flaw of REITs is their lack of growth potential. Because companies which are classified as a REIT must payout 90% of their taxable income to shareholders, opportunities to reinvest their earnings are very limited. As a result, REITs typically grow much slower than non dividend-paying companies. Another flaw in REITs is the tax burden they impose on shareholders. Of course, those who want dividends will not complain about receiving higher-than-average yields. However, it is important to remember that dividends paid out by REITs will be taxed. While the following limitation does not apply to all REITs, it is worth keeping an eye out for. That potential limitation is the high fees which are imposed on shareholders by some REITs.
