Real Estate Investment Trust (REIT)

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What is REIT?

REITs (Real Estate Investment Trust India) were established by Congress in 1960 as an amendment to the Cigar Excise Tax Extension of 1960. They allow individual investors to buy shares in commercial real estate portfolios that receive income from a variety of properties, including apartment complexes, data centres, healthcare facilities, hotels, infrastructure (e.g., fibre cables, cell towers and energy pipelines), office buildings, retail centres, self-storage, timberland and warehouses.

Most REITs specialize in a
specific real estate sector – for example, office REITs and healthcare
REITs – but diversified and specialty REITs may hold various types of
properties in their portfolios. For example, a diversified REIT may hold a
portfolio comprising both office and retail properties. Most REITs have a
straightforward business model: The REIT leases space and collects rents on the
properties, then distributes that income as dividends to shareholders.

REIT
Guidelines

To
qualify as a REIT, a company must comply with certain provisions in the
Internal Revenue Code, including requirements to primarily own
income-generating real estate for the long term and distribute income to
shareholders. Specifically, a company must meet the following requirements
to qualify as a REIT:

  • Invest at least 75% of its total assets in real estate, cash or U.S. Treasuries
  • Receive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate
  • Pay a minimum of 90% per cent of its taxable income in the form of shareholder dividends each year
  • Be an entity that is taxable as a corporation
  • Be managed by a board of directors or trustees
  • Have a minimum of 100 shareholders after its first year of existence
  • Have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year

Types of REITs

There are
several types of REITs, including:

  • Equity REITs – Most REITs are equity REITs, which buy, own and manage income-producing real estate. Revenues are generated primarily through rents (not by reselling properties).
  • Mortgage REITs – Mortgage REITs lend money to real estate owners and operators either directly through mortgages and loans or indirectly through the acquisition of mortgage-backed securities. Their earnings are generated primarily by the net interest margin – the spread between the interest they earn on mortgage loans and the cost of funding these loans. This model makes them potentially sensitive to interest rate increases.
  • Hybrid REITs – These REITs use the investment strategies of both equity and mortgage REITs.

Type of REIT Holdings
Equity Own
and operate income-producing real estate
Mortgage Provide
mortgages on real property
Hybrid Own
properties and make mortgages

REITs can
be further classified based on how their shares are bought and held.

  • Publicly Traded REITs  Shares of publicly traded REITs are listed on a national securities exchange, where they are bought and sold by individual investors. They are regulated by the U.S. Securities and Exchange Commission (SEC).
  • Public Non-traded REITs – These REITs are also registered with the SEC, but don’t trade on national securities exchanges. As a result, they are less liquid than publicly traded REITs but tend to be more stable because they’re not subject to market fluctuations.
  • Private REITs – These REITs aren’t registered with the SEC and don’t trade on national securities exchanges.

Pros and Cons of Investing in REITs

REITs can
be an important part of your investment portfolio. As with all
investments, they have pros and cons that you should consider before
making any decisions.

Pros Cons
Liquidity
– You buy and sell them like stocks.
Low
growth – They pay 90% of income back to investors, so only 10% of taxable
income can be reinvested.
Diversification
– They have low correlation with other stocks and bonds.
Taxes
– Dividends are taxed as regular income.
Transparency
– They are regulated by the SEC and require audited financial reports.
Market
Risk – They don’t guarantee a profit or ensure against losses.
Dividends
– They provide a stable cash flow.
Fees
– Some have high management and transaction fees.
Performance
– They offer attractive risk-adjusted returns.
 

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