The term REIT (Real Estate Investment Trust) refers in a broad sense to a type of organization that owns or invests in real estate or financial instruments related to real estate. REITs come in several varieties, and the differences can cause some confusion. However, the basic structure and requirements are as follows:
A REIT is a pass-through company, which does not pay federal income tax at the corporate level as long as it meets the eligibility standards.
- 75% of total assets must be real estate (or related, such as real estate financing), and at least 75% of the REIT income must come from real estate and related activities.
- REITs must have at least 100 investors (following the first year of operation) and can't allow ownership to concentrate (no more than 50% can be held by five or fewer investors).
- REITs must annually (or more often) distribute at least 90% of their taxable income to investors.
Equity or Mortgage Focus
The more familiar genre of REIT invests in property. These real estate assets can be virtually any type, including multi-family housing, office buildings, industrial space, healthcare, retail, hospitality, self-storage, or another type of property. The income stream for equity REITs derives mainly from the rent paid by tenants in the owned properties.
The second type of REIT is called a mortgage REIT, which buys mortgages and other financial instruments that finance commercial property. This kind of REIT generates its income mainly through interest and fees.
Some REITs, referred to as hybrids, have both property and debt in their asset base.
What About Taxes?
As noted, the corporation or other trust structure does not need to pay federal income taxes if it is eligible as a REIT. However, the individual shareholders report the income they receive and pay taxes at the ordinary income rate. As a result, some taxpayers prefer to hold REIT investments in a retirement account to defer the taxes or exempt the income from tax liability. Always consult your tax and retirement advisor about your circumstances.
Do REITs Have a Limited Lifespan?
Typically, REITs are traded on a stock exchange as securities, like shares in any corporation. According to the Securities and Exchange Commission, there are over 200 publicly-traded REITs in the U.S. currently. Brokers privately trade others, and some are publicly registered with the SEC but not traded. There is no set lifetime for the trust in most cases. Investors who buy publicly traded shares in a REIT can usually buy as much or little as they like and dispose of the shares when they want or need to. However, if an investor buys a non-traded or private REIT, the investment should be considered illiquid. These shares may have a minimum holding period and be more challenging to find a buyer for.
There are some limited, special use REIT examples. One is called a "finite life" REIT. This entity is formed for a specific time, generally due to the type of asset it holds or intends to purchase. When the time for disposition is at hand, the proceeds are distributed to the shareholders rather than reinvested.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate. There are risks associated with these types of investments and include but are not limited to the following: Typically no secondary market exists for the security listed above. Potential difficulty discerning between routine interest payments and principal repayment. Redemption price of a REIT may be worth more or less than the original price paid. Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. There is no guarantee you will receive any income. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes. This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.
