A Crash Course in REITs

Real Estate Investment Trusts (REITs) are investment vehicles that allow individual investors and institutions to gain exposure to real estate without having to purchase physical properties themselves. The structure allows individual investors to earn dividends from real estate investments, as REITs are legally required to pay out at least 90% of their taxable income as dividends. In this article, we will delve into what REITs are, how they work, and the regulatory framework they must adhere to.

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate assets. These assets can include a variety of properties such as office buildings, shopping centers, apartment complexes, hotels, and even warehouses. The primary purpose of a REIT is to generate income for its investors by leasing or renting these properties and distributing the rental income in the form of dividends.

• American Tower is a real estate investment trust that owns and operates a global portfolio of wireless and broadcast communications towers. The company leases space on these towers to wireless and broadcasting companies, providing infrastructure for the telecommunications industry.

• Equity Residential is an equity real estate investment trust that specializes in the ownership and management of apartment communities. EQR's portfolio includes a wide range of rental properties, with a focus on major urban and high-demand suburban areas in the United States.

• Public Storage owns and operates thousands of self-storage facilities across the United States and in several other countries.

• Simon Property Group is one of the largest publicly traded real estate investment trusts in the United States. It primarily focuses on owning and operating shopping malls, premium outlets, and retail centers across North America, Europe, and Asia.

REITs work by pooling capital from multiple investors to purchase and manage real estate assets. They are legally required to distribute at least 90% of their taxable income to shareholders in the form of dividends. This distribution requirement is one of the key features that distinguish REITs from other investment vehicles. The company's legal requirements to distribute income as dividends to its shareholders means that these types of companies have become popular among investors who seek passive income.

• Diversification: REITs provide investors with an opportunity to diversify their portfolios by gaining exposure to various parts of the real estate market without directly owning physical properties.

• Liquidity: Unlike owning physical real estate, REITs are traded on public stock exchanges, providing investors with a level of liquidity. This means investors can buy and sell REIT shares relatively easily.

• Passive Income: REITs are known for their consistent dividend payments, making them an attractive option for investors seeking a regular income stream.

• Professional Management: REITs are managed by experienced professionals who handle property acquisition, management, and other operational aspects.

• Tax Advantages: REITs often enjoy favorable tax treatment, including the ability to avoid corporate-level income taxes by distributing most of their income to shareholders. However, shareholders are generally taxed at their individual tax rates on the dividends received.

REITs are an American invention, and the US is the country in the world with the highest amount of publicly traded REITs. However, the structure is employed by companies all over the world, but no other country has the same scale as the US.

In the United States, the creation of REITs was authorized by Congress in 1960 as an amendment to the Cigar Excise Tax Extension of 1960. The legislation was designed to provide a structure for individual investors to invest in large-scale, diversified portfolios of income-producing real estate in the same way they typically invest in other asset classes through the purchase of stock.

To qualify as a REIT, a company must comply with certain provisions in the Internal Revenue Code. The most important of these are as follows:

• Investment Focus: At least 75% of the REIT's total assets must be invested in real estate, cash, or U.S. Treasuries.

• Income Sources: At least 75% of the REIT's gross income must come from rents from real property, interest on mortgages financing real property, or from sales of real estate.

• Dividend Payout: A minimum of 90% of the REIT's taxable income must be paid out to shareholders in the form of dividends each year.

• Ownership Structure: A REIT must be an entity that is taxable as a corporation, managed by a board of directors or trustees, and has a minimum of 100 shareholders after its first year of existence. No five shareholders can hold more than 50% of its shares.

There are several reasons an investor might choose to invest in a REIT rather than in physical real estate. The first reason is relatively obvious: the barrier to entry is much lower. Whereas investing in physical real estate is expensive, a retail investor can purchase exposure to assets for only a fraction of the cost. While owning a share of a company operating as a REIT isn't directly comparable with owning property outright, it does come with some advantages.

• Diversification: REITs provide investors with an opportunity to diversify their portfolios by gaining exposure to the real estate market without directly owning physical properties.

• Liquidity: Unlike owning physical real estate, REITs are traded on public stock exchanges, providing investors with a level of liquidity. This means investors can buy and sell shares through their broker – further reading on that note; 5 innovative brokers.

• Passive Income: REITs are legally required to pay out consistent dividends, making them an attractive option for investors seeking a regular income stream.

• Professional Management: REITs are managed by experienced professionals who handle property acquisition, management, and other operational aspects.

Real Estate Investment Trusts (REITs) offer investors a unique way to access the real estate market and generate consistent income. However, it's not an investment vehicle that suits every type of investor, as these types of companies can struggle to appreciate in value. Only 10% of the income can be reinvested into new holdings, which in turn means that the acquisition of new properties can be slow. Regardless of this, REITs are generally seen as attractive investments among dividend hunters.