Investing in Real Estate Investment Trusts (REITs) can be a good start in real estate investment portfolio. You may not ‘own’ the property, but you can buy a share in the company that buys, manages, handles, and sells those properties.
REITs is different from real estate syndication as the latter is about investors joining forces together (collect their money) to buy a certain and specific property. How can you benefit from REITs and how it works, anyway?
What Investors Should Know about REITs
REIT refers to a company owning, operating, financing, and managing real estate properties that can generate income. When you invest in REIT, it’s basically similar to buying a bond or a stock from Ferrari, for instance, or from eBay.
You own a share (or a part) of the company, NOT the property. As an exchange for your investment, you will get dividends from your real estate investment without having to actually buy, manage, or finance the properties on your own.
REIT is made to help those who want to invest in real estate, but they don’t really have the ability (or the capacity) to handle the properties. When we are dealing with real estate investment, the most direct and easiest way is to buy a property. Such a direct buying can be quite profitable in tax benefits and return generating.
Unfortunately, not all real estate investors have the expertise, time, and also resources to buy and manage those properties. These kinds of investors would feel satisfied enough to have fractional ownership of a property.
For them, it’s a compelling choice where they can invest money without having to own, buy, or manage the property on their own.
What you should know about REIT and its nature?
- It’s designed and inspired after mutual funds
- REIT is able to generate profitable income stream. What’s important for investors is that it is steady. However, when it comes to capital appreciation, REIT is probably not the best option
- Most REITs are traded publicly, referring to high liquidity benefit
- REIT would typically invest in various (real estate) property types, such as warehouses, retail centers, offices, medical facilities, hotels, data centers, apartment buildings, and even cell towers
REITs business models are generally simple and straightforward. They would lease space or property and then collect rents from them.
Those rents would be distributed as dividends to shareholders, as income. To qualify as REIT, there are certain requirements that they need to have:
- They must invest 75% (minimum) of the total assets in cash, real estate, or US Treasuries
- They must make a minimum 75% of the gross income from mortgage interest (to finance real property), real estate sales, or rents
- Pay at least 90% of the taxable income as dividends on a yearly basis
- Be or act as an entity that is entirely taxable as a business or corporation
- Managed by trustees or board of directors
- Have a minimum of 100 shareholders after the first year (of existence)
- Have not more than 50% of the shares held by 5 (or fewer) individuals
To be considered qualified as REIT, a business (or a company) must follow the rules that have been set by IRC (or Internal Revenue Code). Not many people know this, but Real Estate Investment Trusts have collective $3.5 trillion of worth in gross assets, while the traded equity REITs (publicly) is worth $2.5 trillion of it.
REITs Business Models
Do you know that REITs come in various business models? They have different mechanisms, principals, and purposes.
- Equity REITs. This is one of the most common REIT models. The company owns and also manages the property. Rents are generated from lease and the results would be distributed among investors as dividends.
- Mortgage REITs. The business lends money to real estate operators or owners. They don’t own or manage any property, but they LEND money to property owners or managers or operators. This kind of business gets their income from the net interest margin
- Hybrid REITs. The model combines both mortgage and also equity REITs
Based on how you buy and hold the shares, Real Estate Investment Trusts can be divided into more classifications:
- Publicly traded REIT. The shares would be listed on the (national) securities exchange, where individual investors can buy and sell them. These shares are regulated by SEC (Exchange Commission) and US Securities
- Public non traded REITs. Although they are registered with SEC too, they don’t trade on the securities exchanges. When compared to the publicly traded REIT, they are less liquid. But they have good stability because they aren’t affected by market fluctuations
- Private REITs. They aren’t traded on national securities exchanges and they aren’t registered either with the SEC. They are only available to institutional investors because of their private nature.
Whatever investment type you choose, make sure that you perform the research thoroughly and carefully. REITs are only one among other real estate options, so you can have investment diversification. Real Estate Investment Trusts can be a great investment choice, but only if you do it right.
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