What is a Real Estate Investment Trust, (REIT)?

What is a Real Estate Investment Trust, (REIT)?

A real-estate investment trust (REIT), is a company which owns, manages, or finances income-generating property. REITs pools the capital of multiple investors, similar to mutual funds. Individual investors can receive dividends from real-estate investments, without the need to own, manage, or finance properties.

How REITs Work

REITs were established by Congress in 1960 as an amendment of the Cigar Excise Tax Extension. The provision allows investors to buy shares in commercial real estate portfolios–something that was previously available only to wealthy individuals and through large financial intermediaries

REIT portfolios may include apartment buildings, data centers, hospitals, hotels, infrastructure in the form of fiber cables and cell towers as well as energy pipelines.

REITs are usually focused on a particular real estate sector. However, specialty and diversified REITs can have different types or properties within their portfolios. For example, a REIT may own both office and retail properties.

Many REITs trade publicly on major securities markets. Investors have the ability to buy and sell them during trading sessions like stocks. These REITs trade at a low volume and are considered liquid instruments.

What qualifies as a REIT

REITs tend to have a simple business model. The REIT leases space, collects rents on properties, and then distributes the income as dividends. Mortgage REITs don’t own real property, but instead finance real estate. These REITs receive income from interest earned on their investments.

An organization must meet certain conditions in order to be considered a REIT. These requirements include the need to own long-term income-generating property and share that income with shareholders. For a company to be considered a REIT, it must meet these requirements:

  • Minimum 75% of assets should be invested either in cash or real estate.
  • At least 75% of your gross earnings should come from rents, interest paid on mortgages that finance real properties, and real estate sales
  • Each year, pay a minimum of 90% of your taxable income as shareholder dividends
  • Be an entity that is taxable as a corporation
  • A board of directors or trustees manage the organization
  • At least 100 shareholders within the first year of its existence
  • No more than 50% of the shares be held by five people or less

Types and types of REITs

There are three types REITs.

Equity REITs. The majority of REITs are equity REITs that own and manage income-producing property. The main source of revenue is rents, not reselling property.

Mortgage REITs. Mortgage REITs loan money to real property owners and operators directly or indirectly through the acquisition mortgage-backed securities. Their net interest margin is the difference in the interest they earn from mortgage loans and the cost of financing these loans. This is how their earnings are generated. They can be sensitive to changes in interest rates because of this model.

Hybrid REITs. These REITs invest in both equity and mortgage REITs.

You can further classify REITs based upon how they are bought and maintained.

Publicly traded REITs. Publicly traded REIT shares are listed on a national exchange where individual investors can buy and sell them. They are regulated and supervised by the U.S. Securities and Exchange Commission.

Public Non-Traded Reits. These REITs are also registered at the SEC, but do not trade on national securities exchanges. These REITs are less liquid that publicly traded REITs. However, they are more stable as they aren’t subject to market fluctuations.

Private REITs. These REITs have not been registered with SEC and aren’t allowed to trade on national securities exchanges. Private REITs are generally only available for institutional investors.