A Real Estate Investment Trust (REIT) is a company structured to own or finance real estate projects that seek to generate income. Due to many being available on traditional stock exchanges, REITs are an investment vehicle attainable for the average investor.
REITs allow investment in portfolios of real estate assets. The investors receive a share of any income generated without getting personally involved in buying, selling, or managing the properties.
What Is a REIT?
REITs generally operate in two ways. One method is buying a property that they lease out to tenants. Alternatively, a mortgage REIT does not buy property but helps provide the financing for someone else to purchase real estate.
To qualify as a REIT, a company must comply with the relevant Internal Revenue Code. They must primarily be in the business of owning income-generating real estate on a long-term basis and distribute income to their shareholders.
Other requirements include:
- Earning a minimum of 75% of its gross income from rents, interest on mortgages, or property sales
- Investing a minimum of 75% of its total assets in cash, US Treasuries, or real estate
- Payout of at least 90% of its taxable income as shareholder dividends
- Having a minimum of 100 shareholders after its first year
- Having a managing board of trustees and directors
- Five or fewer individuals may not hold more than 50% of the shares
- It must be taxable as a corporation
Since REITs pay nearly all their income to the shareholders, REITs don’t pay taxes, but the investors pay taxes on any REIT dividends they receive. It is estimated that REIT’s own around $3 trillion in assets.
Types of REITs
There are three types of REITs:
- Equity REITs: Own and manage properties for profit
- Mortgage REITs: Finance other people's purchase of property through mortgages or through acquiring mortgage-backed securities
- Hybrid REITs: Use both investment strategies
How Does it Create Earnings for Investors?
Each type of REIT has its own method of generating income:
- The Equity REIT buys or leases property. It then leases the property or space in the building to various tenants. It collects rent from the tenants. Part of that income is paid to the shareholders as dividends.
- Mortgage REITs don’t buy the property themselves. They lend money to buyers or real estate managers through mortgages and loans. They can also invest in mortgage-backed securities. Their income is derived from the difference between the interest they receive on their loans and the cost of funding the loan. While this is a good business model, it does make this kind of REIT vulnerable to interest rate fluctuations.
- Hybrid REITs use both types of investment strategies to generate income.
How are Dividends Paid/Distributed?
To distribute the dividends, the costs of running the REIT, such as interest payments on funds borrowed, management fees, and taxes, are subtracted from the total income of the REIT. At least 90% of the remainder is then paid out as dividends to the shareholders.
Dividends are typically paid out quarterly, but some REITs payout monthly. REIT dividends are taxed as regular income.
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. It should also not be construed as advice meeting the particular investment needs of any investor. There is no guarantee that companies that can issue dividends will declare, continue to pay, or increase dividends. 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. 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.