How do REITs work?

Just what REIT and how do they work?

Is it time to include real estate to your investment portfolio? Maybe.

Here’s the great news: You can reap the benefits of property ownership without obtaining late-night calls about clogged toilets, or scrambling to fill the area left vacant when that Indian-Canadian fusion restaurant goes under (that, let’s be honest, it will).

Let’s talk about REITs.
Maybe you have wondered who owns the building where you work? Or that new apartment complex they’re building outside? (No? Huh. We thought everybody did that. )#) Nicely, anyways… your building might be owned by Dave, who functions over in Receivables; that cute bartender you were chatting up yesterday; and a retired florist who lives in Fresno, California – that is to say your office building may be owned by the REIT.

Real Estate Investment Trusts, or REITs, are similar in order to mutual funds or ETFs. But instead of owning a container of stocks, the REIT owns a portfolio of commercial or even residential properties or mortgages. Investors can buy shares of a REIT much because they would in a company or mutual fund. REITs, which were developed by federal law in 1960, have become increasingly popular in modern times as people scramble for higher returns on their income-producing opportunities.

REITs provide a great potential upside, including a steady income stream (they have to distribute 90% of their income to shareholders), and the opportunity for solid long-term asset growth reflective of the housing market. REIT’s have averaged an 11. 8% annual return over yesteryear 20 years, compared to 8. 6% for the S&P 500 Catalog. But there are limitations and vulnerabilities, too. Those nice returns reflect the risk inherent in purchasing a narrow category – one that experiences ups, downs and outright collapses on the roughly 15-18 year cycle.
So, it’s important to do a really deep info-dive before purchasing a REIT.

Let’s jump right in…

There are two classes associated with REITs – public and non-traded. Public REITs are traded on stock exchanges while non-traded REITs require shareholders to purchase and sell their shares from the company that operates the trust. Public REITs are the best option for most investors for several reasons, including liquidity. If things go sideways having a public REIT, investors can dump their shares quickly and very easily. That’s not always the case with non-traded trusts. During the actual downturn of 2008, some real estate investment companies froze their own REITs, leaving shareholders stuck with their investment as real estate values went right into a death spiral.

Public REITs also offer greater transparency and, based on research firm Morningstar, better long-term results and faster recovery through downturns than private REITs. What’s more, non-traded trusts often demand upfront fees ranging as much as 12%-15%. And you know how the Wela crew feels regarding excessive fees. (We’re against them. )#)

When shopping for a REIT it’s important to understand the composition and quality of its holdings. Equity REITs obtain commercial property – apartment buildings, shopping centers, warehouses, even timberland — and generate their income from tenant rent. You’re looking with regard to outfits that operate top-notch space with quality, long-term tenants. When the REIT owns a strip center with a vape shop, a location that will sell your stuff on eBay, and the Fairly Kitty Pet Emporium, skip it.

Mortgage REITs earn their living by trafficking in property mortgages and mortgage-backed securities. REITs typically focus on a specific category for example residential (apartment buildings, hotels, manufactured housing), retail (malls and malls), or healthcare (hospitals, assisted living centers, medical workplaces). Investors need to consider the current state and future outlook for any REIT’s chosen sector when evaluating the trust. Many residential-focused REIT’s restrict their investments to specific markets, usually large cities, thus the prospects for all those local economies should be factored into an investment decision.

The caliber and connection with a REIT’s management team is also critical. Real estate is really a savage business. Success requires careful selection of asset properties, efficient tenant recruitment, and highly efficient execution of every management perform from marketing to maintenance. It’s a jungle out there, so stick with established trusts that have a history of maintaining a decent payout across multiple market gyrations.

Keep a watch on the REIT’s debt, too. Trusts that use a significant amount of borrowed capital could be more vulnerable when interest rates rise. Mortgage REITs tend to become more leveraged than Equity trusts.

While the return on REITs could be enticing, don’t go overboard. They should compose no more than 5%-10% of the portfolio. As with any investment vehicle, diversity is critical – the REIT allocation ought to be spread across several real estate categories. A great way to diversify – and avoid hours of research on individual REITs – is to purchase a REIT ETF. Yep – a basket of REITs that consequently hold baskets of properties and mortgages. Can’t get much much more diverse than that!

Real estate is a core element from the U. S. economy, and REIT’s make it possible for the typical investor to participate in its historic growth. Choose wisely and REITs might be, to borrow from one veteran real estate investor, a “terrific” addition towards the portfolio – maybe even YUUUUGE.

How REITs Work

Investing in certain types of REITs also provides the important advantages of liquidity as well as diversity. Unlike actual real estate property, these shares can be quickly sold. And because you’re investing in a portfolio of properties rather than single building, you face less financial risk.

REITs­ came regarding in 1960, when Congress decided that smaller investors should also have the ability to invest in large-scale, income-producing real estate. It determined that the easiest method to do this was the follow the model of investing within other industries — the purchase of equity.

A company must distribute a minimum of 90 percent of its taxable income to its shareholders every year to qualify as a REIT. Most REITs pay out 100 % of their taxable income. In order to maintain its status like a pass-through entity, a REIT deducts these dividends from its business taxable income. A pass-through entity does not have to pay corporate federal or state tax — it passes the responsibility of paying these taxes on to its shareholders. REITs cannot pass tax losses through to traders, however.

From the 1880s to the 1930s, a similar provision is at place that allowed investors to avoid double taxation — paying taxes on both corporate and individual level — because trusts were not taxed in the corporate level if income was distributed to beneficiaries. This was reversed within the 1930s, when passive investments were taxed at both the corporate level and included in individual income tax. REIT proponents were unable to persuade laws to overturn this decision for 30 years. Because of the popular for real estate funds, President Eisenhower signed the 1960 investment trust tax provision qualifying REITs as pass-through entities.

A corporation must meet other requirements to qualify as a REIT and gain pass-through organization status. They must:

• Be structured as corporation, business trust, or even similar association
• Be managed by a board of directors or even trustees
• Offer fully transferable shares
• Have at least 100 investors
• Pay dividends of at least 90 percent of the REIT’s taxable earnings
• Have no more than 50 percent of its shares held by five or fewer individuals over the last half of each taxable year
• Hold at least 75 percent of total investment assets in property
  Have no more than 20 percent of its assets contain stocks in taxable REIT subsidiaries
• Derive at least 75 percent of revenues from rents or mortgage interest

At least 95 percent of a REIT’s gross income must come from financial investments (quite simply, it must pass the 95-percent income test). These consist of include rents, dividends, interest and capital gains. In addition, a minimum of 75 percent of its income must come from certain property sources (the 75-percent income test), including rents through real property, gains from the sale or other disposition associated with real property, and income and gain derived from foreclosure associated with property.