Real Estate Investment Trust (REIT): Criteria, Working, Types, Advantages & Limitations

Real Estate Investment Trust (REIT) is an investing platform that enables investors to invest in real estate assets without actually buying, owning, or managing physical property. Based on the model of Mutual Funds, REITs also pool the money of many investors together and invest the fund collected into income-generating real estate assets like office buildings, shopping centres, apartments, hotels, energy pipelines, and warehouses. Commonly, a REIT is a company that owns, operates, and finances income-producing real estate assets and offers its shares to the general public on the stock exchange. REIT provides an opportunity to invest in a diversified portfolio of different classes of real estate assets with a motive to earn steady income in the form of dividends and ensure capital appreciation in the long run. REITs are listed on a stock exchange, which means shares of these companies can be easily traded publicly, making it a highly liquid investment.

REITs pool up the fund of several investors with the same investing goals and then invest the fund into different real estate assets that generate income. Then the REIT manages the properties, collects rent, pays expenses, and distributes income generated to shareholders in the form of dividends. Investors can easily buy a share of these companies on the stock exchange. When they buy the shares of these companies, they are merely buying a portion of the underlying real estate assets owned by the REIT without actually owning the physical property themselves and vice versa. The value of a REIT’s shares is determined by the free forces of supply and demand in the market and by the performance of the underlying real estate assets. Besides this, REITs provide capital appreciation opportunities in the long run as the value of the underlying real estate assets owned by the REIT can appreciate over time.

A study by Deloitte projects the global REIT market to reach $4.8 trillion by 2027, growing at a CAGR (Compound Annual Growth Rate) of 5.7% from 2022 to 2027.

Real Estate Investment Trusts (REIT) can be classified as:

A. On the Basis of the Nature of the Real Estate Asset

Under this REIT can be classified into three categories:

1. Equity REITs: Equity REITs are the one that owns and operates income-producing properties like healthcare infrastructure, warehouses, offices, and so on. The main source of earnings is the rent generated from the real estate assets. According to Nareit (National Association of Real Estate Investment Trusts), the estimated value of the US equity REIT market was $3.9 trillion as of Q1 2024.

2. Mortgage REITs: These REITs extend loans and finance to the owner of the real estate properties and operate through mortgages and the acquisition of the mortgaged securities. Their earning is a net interest income (the difference between the interest charged and the cost of funding) from mortgage loans.

3. Hybrid REITs: As the name suggests Hybrid REITs are a combination of both equity and mortgage REITs as they own properties as well as hold mortgages.

B. On the Basis of the Nature of Trading

There are three types of REITs under this head:

1. Publicly Traded REITs: REITs are registered with the SEC and publicly Traded REITs are listed on public stock exchanges, and their shares can be easily bought and sold by the general public during trading hours on major stock exchanges like the NYSE.. However, the share’s price is determined by the free forces of supply and demand in the market and by the performance of the underlying real estate assets.

2. Public Non-traded REITs: The shares of these REITs are not registered with public stock exchanges, and so cannot be traded on a stock exchange. The shares are generally sold to individual investors through brokers.

3. Private REITs: Private REITs are also not registered with public stock exchanges, rather the shares are allotted through private placements to institutional investors and high-net-worth individuals.

REITs offer a number of benefits to investors which include:

1. Liquidity: The shares of REITs can be easily sold on the stock exchange market, making it easy for the investor to withdraw as per their will and need. but Non-traded REITs are illiquid. Unlike publicly traded shares, you can’t easily sell them on an open market.

2. Diversification: REITs allow investors to diversify their portfolios by investing in different classes of real estate assets. This help investors scatter the risk into different categories of assets.

3. High Dividend Yields: As per the law, REITs are required to distribute 90% of their taxable income as dividends to shareholders making it a High dividend-yielding investment channel.

4. Access to Real Estate: REITs enable the investor to access the real estate without actually buying and owning the physical property. When an investor buys a share of REITs, they buy a part of the underlying property held by the REITs.

5. Professional Management: REITs are managed by professionals who are experts in real estate management, which leads to better investment decisions and higher returns.

6. Capital Appreciation: The value of properties held by REITs appreciates with time, giving an opportunity to the investors to grow the value of their capital in the long run. 

Everything that offers advantages comes with limitations, and so do REITs. Some of such limitations associated with REITs are:

1. Dividend Fluctuations: The dividend distributed by REITs is highly uncertain based on the fact that the amount of the dividend depends on the performance and income of the REITs. However, unlike publicly traded REITs that prioritize distributions from operational income, non-traded REITs may utilize offering proceeds and even borrowings to fund those payouts. This practice diminishes the value of your shares and limits the company’s ability to reinvest in new properties, potentially hindering future growth. A report by JLL (Jones Lang LaSalle) highlights that dividends can vary depending on factors like occupancy rates and rental income of the underlying properties.

2. Transparency: Valuing your non-traded REIT shares can pose a challenge. Unlike publicly traded REITs, which have accessible market prices, non traded REITs typically delay sharing value estimates until, at least 18 months after their offering closes. This lack of transparency makes it hard to measure how your investment is performing or its potential volatility, over a period.

3. Fees and Expenses: Non-traded REITs typically have higher upfront fees and ongoing expenses compared to publicly traded options. Scrutinize the fee structure before investing.

4. Interest Rate Sensitivity: Whenever interest rates rise, the cost of borrowing for REITs increases, which can lower their profitability and stock prices. REITs are highly sensitive to interest rates.

5. Limited Control: REIT shares are managed by professional managers, so the investors have very little control over the management and operation of the underlying real estate properties.

6. Market Risk: Like any other investment, REITs are subject to market risk. Any market downfall can adversely affect the prices of REITs shares and the value of the real estate. 

7. Taxation: Although REITs are tax-efficient structures, the income generated is taxable as regular income.

A company to be classified as a REIT is required to meet several provisions of the Internal Revenue Code (IRC). Here are the main requirements:

• At least 75% of a REIT’s gross income shall come from real estate-related sources, such as rent or mortgage interest or real estate sales.
• At least 75% of a REIT’s assets shall be real estate-related assets, such as real property, mortgages on real property, or shares in other REITs.
• A REIT must have a minimum of 100 shareholders after its first year of existence, and no more than 50% of its shares can be held by five or fewer individuals. i.e., cannot be closely held.
• A REIT must distribute at least 90% of its taxable income to its shareholders in the form of dividends. A REIT shall be taxed as a corporation, but it can elect to be taxed as a pass-through entity if it meets certain requirements.
• A REIT shall be managed by a board of directors and shall have at least one independent director. However, meeting the above requirement does not necessarily make a company a good investing REIT.

Real Estate Investment Trusts (REITs) offer a smart way to invest in income-producing properties and benefit from the real estate market’s growth without the hassle of property management or hefty down payments..

Step 1: Explore Your Options: REITs come in a variety of types, each specializing in a specific type of real estate as we discussed above in Types of Real Estate Investment Trust (REIT) section.

Step 2: Choose Your Investment Vehicle There are three main ways to invest in REITs:

1. Individual REIT Stocks: This allows you to target specific properties and potentially earn higher returns, but requires more research and carries more risk.
2. REIT Mutual Funds: These pool your money with other investors to buy shares in a basket of REITs. This offers instant diversification and reduces risk.
3. REIT ETFs: REIT ETFs (Exchange-Traded Funds) are similar to mutual funds, but trade throughout the day like stocks, offering more flexibility.

Step 3: Open an Investment Account: To buy REITs, you’ll need an account with a reputable online brokerage firm or investment account. Opening an account is usually a quick and easy process.

Step 4: Conduct Your Research Before you invest, delve into the world of REITs. Here are some key factors to consider:

• The REIT’s Track Record: Look at their financial performance, dividend history, and property portfolio.
• Fees and Expenses: Understand the fees associated with your chosen investment vehicle (e.g., expense ratio for mutual funds/ETFs).
• Market Conditions: Consider the overall economic climate and how it might affect different types of REITs.

Step 5: Diversify and Monitor: Diversification is key to mitigating risk. Invest in a variety of REITs across different sectors. Finally, regularly monitor your investments and adjust your strategy as needed.

Tip: REITs are known for their high dividend payouts. Consider holding them in tax-advantaged accounts like IRAs or 401(k)s to maximize your returns.

While REITs offer an attractive entry point into real estate investing, they are still subject to market fluctuations. Always conduct thorough research and consult a financial advisor before making any investment decisions.

Investing in Real Estate Investment Trusts (REITs) can be a smart way to tap into the real estate market without the hassle of property management. But with any investment, understanding the tax implications is crucial. REITs are known for their steady stream of income through dividends. However, these dividends can be categorized into three parts for tax purposes:

• Ordinary Income: This is the most common type of REIT dividend and is taxed at your regular income tax rate, which can be up to 37% (returning to 39.6% in 2026), plus a 3.8% surtax on investment income. There’s a silver lining though! Until the end of 2025, you can deduct 20% of qualified REIT dividends, effectively lowering the tax rate to 29.6%.
• Capital Gains: Sometimes, a portion of your REIT dividend may come from capital gains earned by the REIT when they sell a property. This part is taxed at the lower capital gains rate of 20% (plus the 3.8% surtax).
• Return of Capital (ROC): This isn’t actually a profit, but a portion of your original investment being returned to you. ROC isn’t taxed, but it reduces the cost basis of your REIT shares, which can impact capital gains taxes when you eventually sell them.

Listing 10 of the largest and most well-established REIT companies in the United States, categorized by their primary property sector specialization:

Investors can find REITs to be an option, for getting involved in real estate without the hassle of owning and running properties directly. Knowing the types of REITs, their benefits and drawbacks and how to invest in them can help you decide if adding REITs to your investment mix is right for you. Remember to do your own research and seek advice, from an financial advisor before making any investment decisions.

What Does REIT Stand for?

REIT Stand for Real Estate Investment Trust.

Are Real Estate Investment Trust (REIT ) a Good Investment?

Yes, REITs can be a valuable addition to a well-diversified portfolio, but it’s important to understand both the potential benefits and drawbacks before investing. It depends on your investment goals and risk tolerance. REITs can be a solid option for income-oriented investors seeking diversification. However, conduct thorough research, understand the risks, and consider consulting a financial advisor before making any investment decisions.

Should I Invest in a Real Estate Investment Trust (REIT )?

REITs can be a good fit if you seek steady income and portfolio diversification. They offer regular dividend payouts and exposure to various real estate sectors, all without the burden of property management. However, remember they are subject to market risks and interest rate fluctuations, and dividends may be taxed at higher rates. Do your research, consider your risk tolerance and financial goals, and consult a financial advisor before diving into REITs.

Are REIT Dividends Qualified?

No, REIT dividends are not considered qualified dividends. This means they are taxed at your ordinary income tax rate, which can be higher than the capital gains rate that applies to qualified dividends. There is a temporary exception, however. Until the end of 2025, a portion of your qualified REIT dividends may be eligible for a deduction of up to 20%. This deduction can help reduce your tax burden on REIT income.

How Often do REITs Pay Dividends?

REITs are known for frequent payouts, typically distributing dividends quarterly or monthly, offering investors a steady stream of income.