What is a Real Estate Investment Trust (REIT)?
A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. Modeled after mutual funds, REITs provide investors of all types the opportunity to own valuable real estate, present the opportunity to access dividend-based income and total returns, and help communities grow, thrive, and revitalize.
Types of REITs
REITs often are classified in one of two categories:
- Equity REITs: The majority of REITs are equity REITs. Equity REITs own and manage income-producing real estate properties and give investors the opportunity to invest in these portfolios. They are responsible for the equity or value of their real estate assets, which are leased out to tenants. Their revenues are generated primarily from the rents.
- Mortgage REITs (mREITs): mREITs lend money directly to real estate owners and operators or extend credit indirectly through the acquisition of loans or mortgage-backed securities. Their revenues are generated primarily by the interest earned on mortgage loans.
How REITs Work
REITs allow anyone to invest in portfolios of real estate assets the same way they invest in other industries – through the purchase of individual company stock or through a mutual fund or exchange traded fund (ETF). The stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy, manage or finance property.
Requirements for a REIT
In order to qualify as a REIT, a company must comply with certain provisions in the Internal Revenue Code. These requirements include to primarily own income-generating real estate for the long term and distribute income to shareholders. Specifically, a company must:
- Invest at least 75% of its 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 sales of real estate
- Pay at least 90% of its taxable income in the form of shareholder dividends each year
- Be an entity that is taxable as a corporation
- Be managed by a board of directors or trustees
- Have a minimum of 100 shareholders
- Have no more than 50% of its shares held by five or fewer individuals
Benefits of Investing in REITs
REITs offer a way for individual investors to earn a share of the income produced through commercial real estate ownership. This is something that otherwise might be possible only for large institutional investors. Other benefits include:
- Liquidity: Because REIT shares are traded on major stock exchanges, they are much more liquid than actual property investments.
- Diversification: REITs often own and operate a range of property types in different geographic regions, providing diversification for investors.
- Dividends: REITs are required to distribute at least 90% of their taxable income to shareholders annually. These dividends can provide a steady income stream for investors.
In summary, a Real Estate Investment Trust (REIT) is a unique type of company that allows individual investors to invest in large-scale, income-producing real estate. By offering the benefits of commercial real estate investment to all investors, REITs have the potential to provide a steady stream of income, diversification, and long-term capital appreciation.