Real Estate Investment Trust (REIT)
- Last Updated: Monday, 26 October 2020
A real estate investment trust, or REIT, is a company or entity that invests in different forms of real estate. These investments can include shopping malls, commercial office buildings, as well as hotels. These trusts can also invest in real estate related assets such as mortgages.
According to the Securities and Exchange Commission, there are three types of REITs:
- Equity REIT: includes the most common type of real estate investment trust, whereby the owners or managers of the trust invest in, or take possession of, real estate assets and make money by charging rents.
- Mortgage REIT: entities that lend money to real estate developers, or invest in financial instruments such as those issued by Fannie Mae, which are secured by mortgages.
- Hybrid REITs: as the name implies, this entity invests in the same manner as both equity and mortgage REITs.
For a company to qualify as a real estate investment trust according to the standards established by the SEC, the company must pay 90% of its taxable income to its shareholders each year. The company must also invest at least 75% of its total monies in real estate, and at least 75% of its gross income must come from investments in property or mortgages.
Investors can participate in REITs through stock exchanges, and those companies that are publicly traded must file reports with the SEC.
Historically, the wealth of an individual was measured in terms of the amount of land a person owned. Today, wealthy individuals can take partial ownership in companies by investing in stocks and bonds. But the door has also been opened for the average investor to participate in the real estate market through REITs.
In fact, when Congress passed the Real Estate Investment Trust Act of 1960, it allowed companies to be exempt from corporate income tax if the criteria mentioned above were met. Congress hoped this financial incentive would result in an increase in the number of investors pooling their money together to form real estate trusts.
Management of Properties
While allowing the average investor to participate in the real estate market is the primary benefit of a REIT, there are other significant benefits from this arrangement such as professional management of the properties. If an individual was to purchase a property on their own, they would be responsible for managing the asset. With a REIT, the properties are managed by industry professionals.
Another benefit REITs offer is the ability to help control or limit risk. If an investor were to purchase real estate directly, they would have to take out a personal loan to help finance the purchase. The success or failure of just one project exposes the investor to a great deal of personal risk.
By investing in a REIT, the individual is purchasing a share of the trust. The risk of failure or success is no longer limited to just one property. The trust would own a diverse portfolio of real estate properties, and the investor automatically benefits from this diversification.
Real Estate Bubbles and REITs
No discussion of real estate trusts would be complete without addressing concerns over real estate bubbles. In many areas of the country, there are often sharp increases in the cost of buying a home. Individual investors also own homes, so they are acutely aware of the rise in housing prices, and the talk of a real estate bubble that may burst at any moment. For this very reason, these same individuals shy away from REITs.
Fortunately, a rise in residential real estate values does not affect all trusts equally. Commercial and residential real estate are very different markets. Just because the values of homes are on the rise has nothing to do with the popularity of businesses such as Public Storage or other entities that invest in commercial properties.
So while the real estate bubble may be of some concern to REITs heavily invested in residential real estate developers, it has very little to do with the performance of trusts investing in commercial real estate.
Real Estate and Retirement
The New York Times once reported that 401(k) plan sponsors were looking to offer participants alternatives to stocks and bonds. Today, many of these plans offer participants real estate mutual funds, which often hold REITs. If a plan administrator does their research, there's no reason they cannot find suitable funds to offer participants.
A well-run REIT is no different than any other well-run business in any other industry. If the company puts together a portfolio of products or services that makes sense to investors and treats its shareholders fairly, then it is likely to prosper regardless of whether or not it is a real estate investment trust or General Electric.
International Real Estate
The popularity in the United States has led to the spread, or promise, of REITs appearing internationally. The three most promising markets include Japan, the United Kingdom, and Germany.
Japan is perhaps the most interesting of the Asian nations to pass REIT legislation back in December 2001. Japanese REITs, also referred to as J-REIT are traded on the Tokyo Stock Exchange. Organizers and participants include foreign investment banks, and conglomerates operating out of Japan.
Since experiencing a drop in property prices in the 1990s, Japan finally appears to be seeing prices starting to increase. If this becomes a trend, the interest in J-REITs will rise sharply.
United Kingdom REITs
More recently, the rules for United Kingdom REITs were established and this legislation was enacted as part of the Finance Act of 2006, which went into effect in January 2007.
As is the case in the U.S, these newly formed U.K. REITS will have to distribute a large share (95%) of its income back to shareholders. Trusts in the U.K. must also be a closed end trust; the fund must be physically based in the U.K. and listed on a recognized stock exchange.
Supporters of these real estate investment trusts in the U.K. have even created an organization known as The REITs and Quoted Property Group. Organizers include leading commercial real estate companies, the British Property Federation, as well as the London Stock Exchange.
The rationale for allowing REITs in Germany stem from a fear of investment loss to competing countries. The hope is that a G-REIT will keep investors interested in the German real estate market.
The laws concerning G-REITs were enacted in June 2007, and made retroactive to January 2007. The qualifications under this program include:
- Real estate investments must be at least 75% of assets
- Real estate investments must account for at least 75% of gross revenues
- A minimum of 90% of all taxable income must be distributed to shareholders through dividends
- While the corporation is tax exempt, shareholders must pay income taxes on dividends
- Finally, each REIT must be established as REIT-AG corporation
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