Investors evaluating options in real estate have ample choices. They can buy property directly and either manage it or use a property manager. They can collaborate with other investors through tenancy-in-common structures or crowdfunding syndications. Or they can invest in a Real Estate Investment Trust (REIT).
What Is a REIT?
A REIT is a company that pools capital from a group of investors and operates like a mutual fund, buying and managing commercial real estate. While typically REITs own or operate income-producing real estate, some instead invest in financing instruments. Either way, the investors purchase a fractional share of the assets and access a portion of any profits without active management.
Most REITs are publicly traded on stock exchanges, further extending their accessibility to individual investors. Unlike a DST (Delaware Statutory Trust), an investor does not need accredited status to purchase shares in a REIT. There are also non-traded REITs. These securities are not as available to investors, typically have a higher minimum buy-in, and are considered illiquid. Both traded and non-traded REITs must adhere to the same structural requirements to be considered qualified:
- The company must focus on real estate investments or finance, with at least 75% of total assets invested in real estate, cash, U.S. Treasury instruments, or mortgage-related financing vehicles.
- At least 75% of gross income must come from activities related to real estate (rent, sales) or financing.
- The REIT must have a board of directors.
- The company must have at least 100 shareholders at maturity and can't concentrate ownership (no more than 50% of shares held by five or fewer investors).
- The REIT must distribute dividends of at least 90% of taxable income to the shareholders annually or more frequently.
Dividends May Be Accompanied by Growth
Since REITs are publicly traded securities like stocks, they are frequently traded on stock exchanges. This fact carries potential advantages and risks. For example, a REIT with strong operations may pay out a higher dividend, increasing the attention it receives and potentially driving up its price. While this outcome may be attractive, it can result in volatility, as with any publicly traded stock.
It’s also helpful to remember that REITs are pass-through entities. That means that the corporation does not pay federal income tax (as long as it complies with the requirement to pay out 90 percent of taxable income as dividends). Instead, it passes the income through to the investors (in the form of those required dividend payments), and the shareholders pay taxes at their income tax rate.
Liquidity Is Likely Available
As noted previously, non-traded REITs have minimum holding periods and may prove challenging to assess. Private REITs may also incur higher commissions, threshold investment amounts, and other potential obstacles such as accreditation. Most REITs, though, are bought and sold quickly on stock exchanges, with their value established by the price that another investor is willing to pay and a market readily available. Availability on a public exchange does not enhance the potential for success of a REIT, but it does make it simpler to access information about the opportunity. The sponsors must report financial details to the SEC as with any publicly traded security.
