A real estate investment trust, or REIT, is a company that owns, and typically operates, income-producing real estate or real estate-related assets. REITs allow an individual investor to earn a share of the income produced by the properties without having to actually go out and buy real estate themselves. REITs are popular because they are provided for special tax consideration and typically offer investors high yields and highly liquid method of investing in real estate.
The Types of REITs
There are three types of REITs, each valuable in its own way. The first is the traditional equity REIT that involves a pooled investor fund that has been or is used to purchase and maintain income property. Investors of these types of properties receive revenue in the form of dividends from the properties’ rents. The second type of REIT is the mortgage REIT and is similar to the equity REIT but with one principle difference, instead of using the rental income as revenue, investors receive dividends in proportional to the amount of interest earned on the mortgage loan. The mortgage REIT can be structure either directly in the form of mortgages or other types of real estate loans, or indirectly through the acquisition of mortgage-backed securities. Mortgage REITs tend to be more leveraged (they use a lot of borrowed capital) than equity REITs. The final type of REIT is a combination of the two previous REITs and adequately called a hybrid REIT. This type of REIT allows an investor to own shares of a company that has both rental properties and mortgage based properties thus allowing for more diversification. REIT assets in any form can include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans. However, most REITs specialize in a specific type of real estate such as apartment complexes or retail complexes.
Many REITs (whether equity or mortgage) are registered with the U.S. Securities and Exchange Commission (“SEC”) and are publicly traded on a stock exchange. These type of REITs are known as publicly traded REITs but there are also REITs that are registered with the SEC but are not publicly traded. These are known as non-traded REITs (also known as non-exchange traded REITs).
What Makes REITs Different?
The principle difference between a REITs and other types of real estate companies is that a REIT must acquire and develop its real estate property or properties to operate them as part of its own investment portfolio instead of reselling those properties after they have been developed. The process to develop a REIT can be a long and tedious process but the potential gains and benefits of owning shares in a REIT can outweigh the risks, if the investments are managed properly.
How to Qualify as a REIT?
The process of becoming a REIT, as mentioned above, is time consuming but the benefits can be exceptional. Under U.S. law, to qualify as a REIT, a company must have the majority of its assets and/or income connected to real estate investments. Additionally the company must also distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends. These are the two primary conditions, there are also the following additional conditions that must be satisfied to qualify as a REIT:
- Be an entity that would be taxable as a corporation but for its REIT status;
- Be managed by a board of directors or trustees;
- Have shares that are fully transferable;
- Have a minimum of 100 shareholders after its first year as a REIT;
- Have no more than 50 percent of its shares held by five or fewer individuals during the last half of the taxable year;
- Invest at least 75 percent of its total assets in real estate assets and cash;
- Derive at least 75 percent of its gross income from real estate related sources, including rents from real property and interest on mortgages financing real property;
- Derive at least 95 percent of its gross income from such real estate sources and dividends or interest from any source; and
- Have no more than 25 percent of its assets consist of non-qualifying securities or stock in taxable REIT subsidiaries.
The Take Away
All investments have their own risks and rewards; REITs are no exception and as an investor you should evaluate your own financial situation or financial advisor before committing to any type of investment.
If you currently own property or properties and would like to hear more about REITs and how they can potentially grant your company access to additional capital to expand and/or develop, then please contact us at (619) 990-7491.
This securities law blog post about REITs is provided as a general informational service to clients and friends of Feinstein Law, PA and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship.
For more information concerning the rules and regulations affecting the going public direct transactions and direct public offerings please contact Feinstein Law, PA at (619) 990-7491 or by email at Todd@Feinsteinlawfirm.com or JDunsmoor@Feinsteinlawfirm.com. Please note that the prior results discussed herein do not guarantee similar outcomes.
