The Basics Of A Real Estate Investment Trust (REIT)

The REIT - Real Estate Investment Trust – is an entity, an investment trust that finances, or owns and operates real estate, such as apartment buildings, and other commercial properties, etc. Designed to offer institutional, as well as the retail investors, a chance to invest in large-scale commercial real estate projects, REITs were created by Congress in 1960. 

As per the law, at least 90% of the annual profits of REITs must be paid out as dividends to investors, and are exempt from corporate income taxes, as long as their activities are restricted to certain commercial real estate activities. A number of states also exempt REITs from state income taxes. Investing in REITs can be done through brokers and can be purchased in small lots. 

Types Of REITs

There are, basically, three major types of REITs:

• Equity REITs – The equity REITs are the largest of the three, and invest in, and own properties through, corporations or trusts. The incomes are generated through rents on these properties. The properties usually are commercial properties, such as shopping malls, and hotels. There is no minimum investment amount, and the equity REITs are traded on the major exchanges. 

The program is designed to buy and hold property for current income, and for future appreciation in market value. The expected return  on investment (ROI) is higher than usual, and equity REITs have done so, since their inception in 1972.

• Mortgage REITs – These REITs invest in or purchase mortgages or mortgage-backed securities. Mortgage REITs also mortgage funds to owners of real estate properties. The interests generated from these mortgages are their incomes. Such REITs take no equity, and are designed to act as lenders. 

• Hybrid REITs – As the name suggests, these REITs are the combination of the other two REITs, and so both, properties, and mortgages are held by them. Such REITs modify their policies as conditions emerge and change, and take advantage of the current market conditions, by either investing in REITs of equity, or lend money. 

REIT – An Alternative Investment

Investing in REITs took off when investors were looking for alternative investment opportunities that were economically sound. The benefits accrued to limited partnerships in the 1970s and the 1980s had long gone, and investors, while looking for alternatives, found investing in REITs beneficial as they had good historical record for producing returns. 

Investing in REITs is a great choice for those who do not want to manage their real estate holdings directly. It is probably one of the best ways of generating passive income. The shares can be bought directly from the REIT managements, a financial planner, or through a brokerage firm. Later, too, they can be bought or sold through brokerage firms. 

REIT shares can be bought and sold, just as you would the stock shares, through stockbrokers. The law does not allow REITs to pass on the tax benefits to the investors, and neither are the losses tax deductible.

REIT managements do not need to borrow funds as they have a lot of capital in hand, from the many investors participating in the programs. This allows them to define the scope and size, and number and type, of the properties they can acquire. As they have not borrowed any money, the breakeven of the occupancy of their rental properties are lower, reducing investment risks, and generating higher profits.

The REITs are designed to generate cash profits for its investors, which are paid in the form of dividends. The performance of REITs have been exceptional in the last 25 years. 64 percent of that time – 16 years – investors in REITs have gained double digit returns on their investments. 

REITs are akin to mutual funds as many of the same rules apply to the form of the organization. In addition, similar rules apply towards tax treatment, liability, and the level of regulatory oversight ,and disclosure. 

Investing in REITs should start the same way as you would in any other stock – by determining the level of risk. Find out what that particular REIT intends to do:

· Does it intend to borrow money
· What kind of properties will it invest in
· Find out whether it is for equity, or debt investing (mortgage)

Many, conservatively, avoid getting into mortgage/debt investing. Mortgage REITs could end up losing money on deals that end up foreclosing on unfinished projects. At the same time, such deals could end up being extremely profitable, but the corresponding risks are higher. 

Though relatively safe, evaluate all risks, and check out the experience of the REIT management in managing real estate.

 

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