The majority of real estate investment trusts (REITs) are publicly traded entities, but it’s usually a long road from their formation to being listed on a publicly-traded stock exchange.
Many REITs start out as property management companies that own and manage income-producing real property assets. There are two main types of REIT entities: equity and mortgage REITs. Equity REITs focus on investments in various commercial real estate sectors, while mortgage REITs provide financing for commercial and residential mortgages and mortgage-backed securities.¹
In this article we’ll take a closer look at how REITs are formed and the many organizational and operational requirements to which these companies must adhere.
Newly formed REITs are private business entities prior to listing on a major exchange -- there are just under 180 REITs listed on the NYSE.²
These organizations must adhere to numerous organizational and operational requirements to qualify as real estate investment trusts and receive an exemption from taxation at the corporate level. Among them:
REITs also must have a board of directors or board of trustees, and all shares must be transferable.
In order to meet the 100 shareholder requirement, you’ll have to solicit capital from private investors through a prospectus, or private placement memorandum. This document, which outlines your investment offering, is absolutely critical to ensuring your newly formed REIT gains the momentum needed to attain and retain enough shareholders to meet REIT status.
Your prospectus should tell the following story:
The prospectus should close with a subscription agreement, which is the legally binding contract between the issuer and investor. A well-outlined prospectus is absolutely critical to raising capital and bringing shareholders into the company.
Lastly, many REITs focus on one sector of commercial real estate, such as hospitality, retail shopping centers, or healthcare and managed-care facilities. Management should outline their extensive expertise in these areas and how that knowledge can potentially translate into shareholder value when writing their private placement memorandums.
REITs must file a Form 1120-REIT when filing tax returns to avoid taxation at the corporate level. They also must mail out a letter to shareholders each year that delineates shareholder ownership interests.³ This document helps REIT managers verify the 100 shareholder and 5/50 requirements.
REITs also must distribute a minimum of 90 percent of taxable income back to shareholders in the form of dividends in order to avoid taxation. For investors, it's important to understand how REIT dividends are taxed.
Forming a REIT is complicated -- particularly with shareholder ownership.
If you are considering forming a REIT, it might be best to seek counsel from experienced securities, tax, and banking professionals to ensure you meet the many organizational and operational stipulations, as well as meet and maintain IRS requirements for REIT filing status. Lastly, if writing isn’t your thing, consider engaging professional help when penning your prospectus, since you likely won’t attract a large pool of serious investors without nailing this formal offering document.
Sources:
1. Guide to Mortgage REIT Investing, Nareit, https://www.reit.com/what-reit/types-reits/guide-mortgage-reits
2. REIT Industry Monthly Data, September 2021, Nariet, https://www.reit.com/data-research/reit-market-data/reit-industry-financial-snapshot
3. Deadline For REIT Shareholder Demand Letters, Ernst & Young LLP, https://taxnews.ey.com/news/2021-0006-january-30-2021-deadline-for-reit-shareholder-demand-letters