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Investing in REITs (Real Estate Investment Trust)

Investing in REITs (Real Estate Investment Trust)

Imagine that you could invest in real estate with all the advantages and a few disadvantages of the market. You can skip the process of buying and maintaining a property and jump straight to real estate income. This type of investment bliss is what REITs offer.

To know how to invest in a real estate investment fund, you must be well informed about the sector/market. We've put together the information you need to get started and make the right decisions about your real estate investment.

What is REIT?

REIT stands for a real estate investment trust.

A REIT (real estate investment trust) is a company that owns, manages, or finances real estate, particularly income-generating real estate. Simply put, REITs receive money from various investors and invest the amount in commercial properties, such as apartments, malls, hotels, and warehouses. REITs do not develop properties for resale but rather develop properties to operate and earn a substantial income. Investors benefit from a constant stream of dividends and the appreciation of their stocks.

Real estate investment trust allows investors to diversify their portfolios and earn profits in the real estate market without buying, finance, and managing properties.

Therefore, it is known that the best REITs offer high profitability and capital appreciation. This capital increase or appreciation is what involves significant risk, depending on the type of REIT.

How does a real estate investment fund work?

In 1960, Congress created REITs to allow a variety of individual investors, not just the wealthy, to buy shares in commercial real estate portfolios.

Investors can invest in a real estate investment fund the same way they normally would in any other company. This is done through the acquisition of shares of individual companies or mutual funds. REIT then pays shareholders a constant income from the income generated by real estate investments.

These investments can take any form, from mortgages to stocks or a combination of both. 

Income-generating properties or REIT portfolios may include condominiums, healthcare facilities, hotels, office buildings, shopping malls, warehouses, etc.

A REIT firm may also focus on a certain type of property or on different types of properties.

Most REITs can be listed on a stock exchange, and investors can buy and sell them in the same way as the stock exchange trades during trading sessions. As is customary in the real estate market, REITs are considered very liquid instruments.

On the asset side, REITs have gross assets of over $3.5 trillion in the United States. Additionally, publicly-traded REITs have approximately $2.5 trillion in assets.

What qualifies a REIT?

To qualify as a REIT, a business must meet the Internal Revenue Code standards (IRC). These standards include:

  • A real estate investment fund must not hold more than 50% of its shares belonging to five shareholders or less during the last half of the financial year. To ensure overall compliance, most REITs limit investor participation to 10%.

  • A REIT must be structured and taxable as a corporation. It must also have a minimum of 100 shareholders after its first year of existence. Because of this 100 shareholder requirement, many REITs started as real estate companies before later becoming REITs.

  • A REIT must invest at least 75% of its total assets in real estate, US Treasury securities, or cash.

  • Real estate investment funds must also earn at least 75% of their gross investment income. This includes sources such as rent, mortgage payments, and other real estate sources.

  • A board of directors must manage REITs.

  • REITs must pay shareholders at least 90% of their taxable income as dividends each year. This particular requirement makes REITs one of the best interest rates and high investment dividends. Some REIT companies even pay 100% of their taxable income.

One of the main reasons a business wishes to qualify as a REIT is not paying corporate taxes; this means that there is no taxable profit in the business. No matter how much income a real estate fund earns, they must never pay corporate taxes. Taxes are only levied in the form of taxes on individual dividends. This is generally a big plus for these companies.

Types of REIT

We mentioned earlier that REITs could take many forms in the real estate market. These modules are called REIT types.

  • Equity REIT: These are the most common types of REITs. In real estate investment funds, the company owns and manages the building. They operate as owners, providing maintenance, reinvestment, and control collection. Equity REITs mainly focus on commercial real estate, and the source of income is rental income. Examples of equity REITs are shopping malls, nursing homes, and condominiums.

  • Hybrid REITs: As you may have guessed, a hybrid real estate investment fund is a combination of a mortgage and equity REIT. These companies have a portfolio that includes real estate ownership and management for rental income and real estate mortgages against interest. There are only a few hybrid REITs.

  • Mortgage REITs: Mortgage REITs or mREITs are different from their equity counterparties. Instead of owning the property, the company guaranteed the debt securities. Mortgage REITs provide loans to homeowners, either directly or indirectly. Income is generated through net interest, and mortgage REITs are primarily classified as financial stocks because of this approach. Mortgage REITs generally pay higher dividends and therefore present a higher risk than the type of shares.

Tax implications of REIT investments

While the absence of corporate tax is certainly an advantage for REITs and their investors, the caveat is that REITs' tax structure can be quite complex.

First, most REIT dividends do not meet the IRS definition of "eligible dividends," which would allow them to lower their tax rates. For example, someone in the 22% tax group typically pays 15% of eligible dividends, but REIT dividends generally do not qualify for this leniency.

However, since REITs are transfer assets, dividends from REITs that are not considered eligible dividends generally qualify for a 20% deduction from qualifying business income (QBI). In other words, if you receive $1,000 in regular dividends from an investment in a REIT, only $800 of that amount can be taxed.

Also, REIT dividends generally have several different elements. Most of every distribution you receive from a REIT is generally treated as income, but some may meet the definition of an eligible dividend. A portion of the REIT's distributions may also be viewed as a return on equity, which is not taxable but reduces its cost base in the REIT and could have future tax consequences.



Dennis Jao
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