What Are REITs?

Dec 05, 2023 By Triston Martin

REIT is a kind of mutual fund that invests in properties and real estate to generate income for its unit holders. This revenue comes from the properties and real estate investing. An Initial public offering is a method used by a REIT Management Company, also known as an RMC, to solicit financial backing from the general public. In the event of a Rental REIT Scheme, the RMC will then acquire a property and rent it out to tenants. After then, the rent is divided among the owners of the individual units.

In the event of a developmental or hybrid REIT Scheme, it is the responsibility of an RMC to choose the project, acquire public funds via an initial public offering (IPO), build the property, and then either sell it or rent it out. The money that was made from selling units or the rent was split among the owners of those units.

How REITs Work

Individuals can engage in large-scale, income-generating real estate using real estate investment trusts. A firm that owns and often manages income-producing real estate or other assets connected to real estate is referred to as a REIT. Office buildings, retail malls, apartment complexes, hotels, resorts, self-storage facilities, warehouses, and loans or mortgages might be included in this category. A real estate investment trust, sometimes known as a REIT, does not engage in developing real estate holdings to resell such properties. Instead, a REIT is an entity that acquires and develops properties largely to manage them as part of its investment portfolio.

REITs usually specialize in one real estate sector. Diversified and specialty REITs might have different properties; for example, one REIT may own retail and office properties. Investors can trade REITs like stocks during trading sessions, as they are often publicly traded on major securities markets. These REITs are liquid instruments and trade in large volumes.

What Qualifies as a REIT?

REITs operate on a simple business model. They lease space, collect rents from the properties, and distribute that income to shareholders. Mortgage REITs do not own real estate but finance it. These REITs make income from the interest they invest. A company must follow certain requirements to qualify as a REIT. These include the obligation to own long-term income-generating real property and to distribute that income to shareholders. To qualify as a REIT, a company must fulfill the following requirements:

  • Rents, mortgages financing interest on real property, or sales of real estate should not exceed 75% of your gross income
  • Divide your taxable income each year by paying at least 90% in shareholder dividends
  • You can be a corporate entity
  • Managed by a board of trustees
  • At least 100 shareholders in its first year of existence
  • Five or fewer people cannot hold more than 50% of the shares

Equity REITs

Many REITs are equity REITs that own and manage income-producing properties. Rents generate the majority of revenues and do not resell properties.

Mortgage REITs

The mortgage REITs lend money directly to real estate operators and owners through loans and mortgages or indirectly through purchasing mortgage-backed securities. The net interest margin, the difference between the interests they receive on mortgage loans and the cost to fund these loans, is their main source of income. They are therefore potentially vulnerable to increases in interest rates.

How to Invest in REITs

You can invest in REIT mutual fund or REIT ETFs by purchasing shares from a broker. A broker or financial advisor can help buy shares in a non-traded REIT. REITs are included in increasing numbers of defined-benefit or defined-contribution investment plans. According to Nareit, a Washington-based REIT research company, an estimated 145 million Americans own REITs directly or through retirement savings and other investment funds.

Pros and Cons of Investing in REITs

Because they offer a stable, strong annual dividend and long-term capital appreciation, REITs are a good option for an investment portfolio. The REIT total returns performance over the past 20 years has been better than the S&P 500 Index and other indices, as well as the inflation rate. Like all investments, REITs come with their advantages and disadvantages.

The plus side is that REITs can be bought and sold easily on most public exchanges, mitigating some traditional drawbacks associated with real estate. Performance-wise, REITs are attractive because they offer stable cash flow and risk-adjusted returns. A real estate presence is a good option for portfolio diversification and income. The dividends can often be higher than what you could achieve with other investments.

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