What Is a REIT (Real Estate Investment Trust)?

What is a REIT?

A real estate investment trust (REIT, pronounced “reet”) is a security that directly invests in real estate, by buying and selling property much like stocks on exchanges. REITs are essentially mutual funds that invest in real estate. 

A REIT invests via properties or mortgages and receives special tax considerations. As investor incentives, REITs offer high yields and a liquid method of investing in real estate. In other words, REITs are corporations that own and manage portfolios of real estate properties and mortgages; anyone can buy shares in a publicly traded REIT. 

Why were REITs developed?

Investing in real estate isn’t financially feasible for most Americans. Commercial real estate, in particular, is expensive and requires a significant upfront investment. It’s not easy to qualify for a commercial real estate loan. However, a REIT pools several small investors’ resources and allows them to invest in large-scale commercial real estate as a group. 

A REIT provides advantages in the form of liquidity and diversity; unlike with true real estate, you can easily sell shares. With a portfolio of properties instead of a single piece of property, shareholders face much less financial risk.

REITs were first developed in 1960 to democratize the real estate market following the equity-purchase investment model. At least 90% of a REIT’s taxable income must be distributed annually to shareholders as dividends. 

REITs are permitted to deduct dividends paid to shareholders from their corporate taxable incomes to maintain pass-through entity status, so most REITs owe no corporate tax. As a result, the REIT passes the responsibility of paying these taxes to its shareholders.

What qualifies as a REIT? 

To qualify as a REIT (as overseen by the IRS), a company must have at least 75% of its assets tied to real estate investments. The corporation must be structured as a business trust, and a board of directors or trustees must manage it. Shares must be fully transferable, and each REIT must have at least 100 shareholders.

REIT qualification is also dependent on the company’s makeup. Five or fewer individuals can hold no more than 50% of its shares during the last half of each taxable year. At least 95% of a REIT’s gross income must come from financial investments, and at least 75% of its gross income must come from rent or mortgage interest.

What are the types of REITs?

The three REIT types are equity REITs (eREITs), mortgage REITs (mREITs) and hybrid REITs. 

• eREITs purchase, own and manage real estate properties that produce income, such as apartments, malls and office buildings. eREITs are a good choice for long-term investing because dividends are earned from rental income and capital gains from property sales. eREITs make up 90% of the REITs in the United States.
• mREITs don’t invest in properties. Instead, they loan money for mortgages to real estate owners or purchase mortgage-backed securities. The interest earned on mortgage loans creates mREIT revenue. If interest rates are low or expected to drop, mREITs are considered solid investments. mREITs are more volatile in a market with changing interest rates, as their dividends come from interest payments. As a result, mREITs make up only 10% of the REITs in the United States.
• Hybrid REITs are a combination of equity and mortgage REITs. They earn money through a combination of rent and interest. They combine the investment strategies of mREITs and eREITs and provide a more diversified portfolio.

As of 2022, there were 225 REITs registered with the U.S. Securities and Exchange Commission (SEC). Most of them trade on the New York Stock Exchange. These REITs’ combined equity market capitalization is a whopping $1 trillion.  

Some REITs aren’t publicly traded, and some aren’t registered with the SEC. According to the IRS, roughly 1,100 U.S. REITs have filed tax returns.

Is a REIT a good investment?

In short, yes. Because of the high yields and liquidity, a real estate investment trust is great for those who want to invest in real estate but don’t have the capital to buy property. There is also less financial risk involved with owning shares in a REIT because it’s a mixed portfolio of various real estate properties instead of stock in one particular property.

What are the downsides of REITs?

While REITs have many advantages, there’s some risk involved. Keep these drawbacks in mind when you’re deciding whether to invest in a REIT:  

• Little or no growth. Typically, a public REIT gives away 90% of its revenue to its investors. That leaves the fund with little money to purchase new properties or maintain old ones. Although the account can still appreciate, it won’t do so as fast as other investment options. If you want a higher growth rate, a private REIT could be better for your portfolio.
• Lack of control over returns. While a REIT frees you from paying to maintain a property, it also results in less control over your investment’s value. Directly investing in real estate means you can personally search for high-value locations, market them for use, and screen potential tenants.
• Higher taxes on investment profits. Your REIT will typically pay you dividends, which are taxed higher than income generated by property in which you invest. These taxes can cut a significant amount from your overall revenue, which already doesn’t have much opportunity for growth.

How do you make money on a REIT?

There are two ways to make money with a real estate investment trust: dividends and trading.

• Dividends. First, shareholders can be paid dividends. Dividends are a portion of the taxable income for a company or portfolio. For REITs, that portion is at least 90%. This sum is then divided among shareholders.
• Trading. The other way to make money is through trading. By buying and selling shares of REITs, shareholders can determine when the prices of their shares have peaked to decide when to trade. For example, if a share is purchased for $100 and sold 10 years later for $250, the shareholder will have made $150. It is crucial to track the prices of the owned shares to ensure profit.

How do you invest in REITs?

To invest in a real estate investment trust, buyers must find a trusted broker or financial advisor. Depending on their holding company, these financial experts will have access to various publicly held and nontraded REITs and can offer investment tips informed by market intelligence. They will be able to customize your investment portfolio to meet your needs. 

Although it’s essential to seek advice from a credible broker or financial advisor, it is also important to go into an appointment with an understanding of REITs and questions about how to supplement your investments. Any person who sells REITs must be registered with the SEC; not doing so is considered fraud. To see if someone is registered with the SEC, use the SEC EDGAR system.

Parting advice

Investing in real estate without the necessary starting capital can be challenging, but REITs help make it possible. Of course, as with any investment, REITs have unique rewards and drawbacks. If you’re thinking about using a REIT to purchase a stake in a property, ensure your broker is reputable. Additionally, keep in mind that you won’t make a profit quite as fast as you would with a personal investment, so try to diversify your portfolio. 

Elaine J. Hom contributed to the writing and reporting in this article.