What is a REIT?
By: Olivia Faucher,
“What is a REIT?” a curious investor might ask.
REITs, or otherwise known as Real Estate Investment Trusts, are a great way to diversify and add growth to an investment portfolio. Investing in REITs is also an easy way for investors to gain exposure to the real estate market.
A REIT is a company that owns, operates, or finances real estate that produces income. There are a wide range of property types that REITs invest in, including apartment buildings, warehouses, offices, retail centers, medical facilities, data centers, hotels, cell towers and farmland. Typically, REITs focus on an individual property type, but some REITs do have portfolios that consist of a variety of property types.
What is a REIT? Well-Known Ones Include…
How Do REITs Work?
Generally, REITs follow a simple business model: the company buys or develops properties and then leases them out to collect rent as its primary source of income. The income generated by the company is paid out to shareholders in the form of dividends. REITs are required to pay at least 90% of the company’s taxable income to shareholders, and the shareholders pay the income taxes on those dividends.
However, some REITs do not own any property, choosing the alternate route of financing real estate transactions. These REITs generate income from the interest on the financing. Mortgage REITs are an example of REITs that do not actually own properties. Mortgage REITs will be discussed in further detail below.
What is a REIT? Types of REITs
REITs can be classified into four categories. The categories are: equity, mortgage, public non-traded and private.
- Equity REITs: The majority of REITs are equity REITs. Equity REITs own or operate income-producing real estate, and they are publicly traded on major stock exchanges. Equity REITs are often simply referred to as REITs.
- Mortgage REITs: Also known as mREITs, mortgage REITs provide financing for real estate by buying or originating mortgages and mortgage-backed securities. mREITs earn income from the interest on the investments.
- Public Non-Traded REITs: Public, non-traded REITs are registered with the Securities and Exchange Commission (SEC) but do not trade on national stock exchanges.
- Private REITs: Private REITs are exempt from SEC registration and the shares do not trade on national stock exchanges.
How to Invest in a REIT
If a REIT is listed on a major stock exchange, investors can easily buy shares the same way any other public stock is purchased.
Investors can also invest in REITs through a REIT mutual fund or a REIT ETF (exchange traded fund).
Private REITs and Public non-traded REITs can also be purchased, however it is more complicated. Those investments are generally limited to individuals and institutions who meet certain financial criteria.
REIT Pros and Cons
As with any other investment, it is important to consider the advantages and disadvantages of adding REITs to a portfolio. REITs definitely offer lucrative upsides, but investors should also be aware of the drawbacks associated with them.
What is a REIT? Pros and Cons
- REITs provide diversification within an investment portfolio
- Exposure to real estate market, which can be lucrative depending on economic conditions
- REIT shareholders earn high dividends
- REITS can be volatile since they are subject to market risk
- Potentially high taxes associated with REITs
- Possibility of steep management and transaction fees
What Makes a Company Distinguishable as a REIT?
In order to be classified as a REIT, a company must meet the following criteria:
- Invest at least 75% of total assets in real estate.
- Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from real estate sales.
- Have a minimum of 100 shareholders.
- Be an entity that is taxable as a corporation.
- Be managed by a board of directors or trustees.
- Have no more than 50% of its shares held by five or fewer individuals.
- Pay at least 90% of taxable income as shareholder dividends each year
What is a REIT? The Bottom Line
REITs are a great option for investors who are looking to add real estate to their portfolio. REITs offer multiple advantages, and can be incredibly profitable depending on the market conditions. However, it is important for investors to be well informed about everything that REITs entail before deciding to invest.
Olivia Faucher is an editorial intern with Eagle Financial Publications.