Investing in Real Estate Investment Trusts

Real Estate Investment Trusts, usually called REITs, are a type of investments that offer investors the chance to get into the real estate market without having to become a landlord with a rental property. Many investors simply do not have the resources to get heavily involved in real estate investments, and yet, by adding their resources to that of other investors, it becomes possible. REITs might also be termed “real estate stock” and they allow anyone to participate in buying a publicly traded share.

 

Some REIT types actually allow diversification and liquidity as well. Instead of being invested in one building, the investor is invested in a property portfolio, which ends up being less risky. The shares can also be sold easily and quickly, which is not a feature of buying a single piece of real estate. The REIT began in 1960 when the government allowed smaller investors to participate in the benefit of owning large pieces of real estate for the purpose of income production. The main idea is in purchasing equity. In order to be a REIT, a corporation must meet the following criteria:

 

– Have shares that are fully transferable

– Have a board of directors as management

– Have a structure like a corporation or similar

– Possess a minimum of 100 shareholders

– Be able to pay a minimum of 90 percent dividends on the taxable income

– Have less than half its shares held by less than five people during the last half of a tax year

– Have a minimum of 75 percent of its assets in real estate

– Produce a minimum of 75 percent of gross income from real estate sources such as rent or interest

 

There are several different types of REITs spread throughout three main categories. The three categories of REITs are Equity REITs, Hybrid REITs, and Mortgage REITs. Equity REITs, or REITs, own large business complex real estates such as malls, apartment complexes, and office buildings. They purchase and manage these properties specifically to generate income in a portfolio, as opposed to purchasing for resale. Long-term investors may want to look at REITs due to their superior potential for income through several sources.

 

Mortgage REITs, or MREITs, loan mortgage money instead of investing in real estate property. They may loan money to those looking to purchase real estate, or they may buy mortgages or securities backed by mortgages. Revenue is typically produced through interest on the mortgages. MREITs are more quickly affected by interest rate changes because of this. As of 2015, there are about 40 MREITs, and of these, slightly over half are into securities from residential mortgages, while the rest are into commercial. MREITs are especially attractive as a speculative investment when rates are low or expected to drop.

 

Hybrid REITs, or REITs, combine the other two types of REITs. They purchase and own property and they also offer loans to property owners and managers. These REITs consequently derive income from both interest and rent. Certain types of REITs may have a fixed time limit, having been created for a specific project. Once that project is completed, the REIT is dispersed and any profits are distributed among the shareholders.

 

REITs operate with external funding to fuel their capital. Investors own a portion of the pooled investments. The income of a REIT comes from the renting, buying and selling of real estate properties and is then transferred to the holder on a consistent time table. The income is equally distributed among the number of shareholders. REIT income is calculated through funds from operation. The National Association of Real Estate Investment Trusts allows FFO to include net income through property sales. It excludes property sales with either losses or gains. FFO is designed to keep track of a REIT’s income flow from real estate properties while deducting financing and managerial costs. The net income assumes asset value decreases over time with a consistent trend. However, real estate typically keeps value or increases in value. According to general accounting principles, the land stays the same, while structures eventually depreciate to nothing. Because the main focus of a REIT’s business is real estate, the FFO system was developed to exclude depreciation.

 

However, FFO is not completely airtight. It is generally recommended that investors look at quarterly reports to get a better idea of a REIT’s capital and any other expenses. Since REITs are usually publicly traded, they give investors a great opportunity to diversify and balance their portfolio. They can give investors the chance to earn long-term income through dividends and capital gains. They further have an advantage over most other stock types because of the pass-through taxes. As long as the REIT continues to pay out 90 percent of its income to shareholders, it continues to not be taxable. Because of that, shareholders get even more of the earnings without the cut from taxes.

 

REITs are also notable for decent inflation resistance and consistent revenue flow. Because many REITs derive income from rent, they are automatically adjusted for cost of living and thus for inflation. The main disadvantages of REITs are the lack of eligibility for a 15 percent tax rate on dividends that came into being in 2003. This translates to investors having to pay as much as 35 percent for the general income tax. Distributions that are not taxable, are then taxed like capital gains. This can be as much as 15 percent.

 

REITs, as a property investment trust, typically require much less time and energy spent vs purchasing various real estate property. That said, good research is a must for any investor looking to get into REITs. Real estate training or a real estate license course might come in handy for researching REITs. Choosing a REIT involves many factors, including the investor’s own needs and the management of the REIT. Investors should be wary of REITs with very high yields. This may indicate income from temporary sources, which will not continue in the future. It is also good to make sure that the REIT is not deriving income from only selling properties as this hampers future rental income.

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