A house

What is a Real Estate Investment Trust?

Real Estate Investment Trusts, or “REITs,” provide unique investment opportunities that allow all Americans (not just the ultra-wealthy) to easily benefit from high-value real estate. REITs operate similarly to mutual funds, meaning that the actual real estate itself is not directly owned by investors; rather, investors share in the profits of REITs through cash dividends.

Buying into a REIT is like purchasing stock in a company that buys, finances, and manages real estate for you while you receive the cash benefits of their work. While the REIT navigates the intricacies of the real estate market, investors earn income in the form of cash dividends paid directly from the income the REIT makes. This allows everyday consumers to reap the benefits of otherwise inaccessible real estate investments such as large medical facilities, warehouses, and data centers.

What legally qualifies as an REIT?

In order to qualify as an REIT, a company must comply with the Internal Revenue Code by meeting all of the following requirements:

  • REITs must invest at least 75% of their assets in real estate.
  • At least 75% of the income made by an REIT must come from rents, interest on mortgages that finance real property, or real estate sales.
  • At least 90% of the income made by an REIT must be paid to shareholders in the form of shareholder dividends (many REITs pay out 100%)
  • REITs must be an entity that is taxable as a corporation.
  • REITs must be managed by a board of directors or trustees.
  • REITs must have at least 100 shareholders.
  • No more than 50% of the shares of an REIT may be held by 5 or fewer individual shareholders.

If you are unsure whether a REIT is legitimate, you can check the SEC’s website using their EDGAR tool. Most REITs are registered with and regulated by the SEC, so they will appear in this public database. Some REITs are private REITs that are exempt from SEC regulation, and while they can still be valid options, investors may be placing themselves at a higher risk of fraud.

How do you invest in an REIT?

Many REITs are publicly traded on major securities exchanges, meaning they can be bought and sold just like regular stocks. Before investing in REITs, it is important to understand the 3 types:

  • Equity REITs are the most common type, and they earn income by managing real estate.
  • Mortgage REITs (mREITs) earn income from interest on mortgages or mortgage-backed securities.
  • Hybrid REITs earn income from both the management of real estate and mortgages.

It is important to note that just because an REIT is public and SEC regulated does not mean that it can be traded on national stock exchanges, as some REITs chose not to be listed.

What are the advantages and disadvantages of investing in an REIT?

Due to the structure of a REIT, no actual management of real estate is required, but the income generated by the managing company is directly transferred to investors in the form of stable cash dividends. Unlike actual real estate investments, REITs have high liquidity because they are publicly traded like stock. This allows investors to diversify their portfolio with real estate, but with more attractive risk-adjusted returns and stable cash flow through dividends.

Because REITs must pay out at least 90% of their income as dividends, this leaves little additional income for reinvesting, meaning that REITs grow very slowly—if at all. Despite their slow growth, REITs are not free from general market risk and can still depreciate or completely fail like regular stocks. Additionally, many REITs charge high management and transaction fees to make back the money they lost as dividends.

Should you invest in a private REIT?

We aren’t here to offer investment advice, but if you’ve been approached with the opportunity to invest in a “private” REIT, it’s important to do due diligence. This includes ensuring that the properties claimed to be owned by the REIT are indeed owned and are free and clear (or mortgaged in the amounts advertised). Investments in private real estate groupings comes with unique risks, and you should have a lawyer look at any documents before you sign them.

Finally, if you’ve been cheated by a REIT owner or manager, it’s important to speak to counsel right away. An attorney can help figure out if you have any rights to go after funds or their managers if they have breached their obligations in managing the REIT or other investment vehicle.

Conclusion

REITs offer a simpler way to diversify your portfolio with real estate with a lower entry cost and more favorable risk-adjusted returns without the hassle of managing real estate. If you have questions about the legality of what you’ve been offered, or if you need help figuring out how to protect a real estate investment in Pennsylvania, call Cornerstone Law Firm today.