Real estate investing is a proven method of generating wealth over the long term. This type of investing generates both a capital gain and a steady income that is protected from inflation. The one thing that keeps investors away from this great investment opportunity, however, is the large amount of time and effort required.
One way to get exposure to the real estate sector without the hassle is by owning a real estate investment trust (REIT). This involves investing in a public or private company that owns a portfolio of real estate properties or, in some cases, mortgage assets.
This article will focus on answering many questions you may have about this type of investment, including: “What are REITs and how do they work?,” “What are REIT investments’ pros and cons?,” and “How are REITs taxed?”
What Is a REIT?
A real estate investment trust is a company that owns or finances real estate properties that generate an income. Most REITs trade on the major trading exchanges and can be purchased as easily as a stock. That said, a smaller REIT may trade as a private entity until it grows enough to trade on the exchanges.
A REIT contains many properties, which are financed by a professional management team that will make the decisions with the goal of benefiting unitholders over the long term. And the great thing about owning a REIT is that you end up having a portion of capital allocated towards real estate without needing to be or manage tenants.
Depending on the goals of the REIT, the properties within the portfolio could be focused on a certain geographic area or spread across a few countries around the world. The properties also often need to fit a certain criteria; for instance, a REIT may focus solely on investing in office buildings in large cities or owning industrial properties. Common market segments for REITs include hotels, hospitals, student housing, mortgages, and apartments, giving investors a lot of options.
A REIT gives investors the ability to invest in large-scale properties that would otherwise be unavailable. They also provide access to a diversified portfolio of properties that generate a capital gain through price appreciation.
Here are the criteria that a REIT must follow:
- Pay at least 90% of its taxable income to shareholders as a dividend
- Invest at least 75% of the total assets in real estate
- At least 75% of the gross income must come from rents on properties, interest from mortgages, and/or the sale of real estate
- Be taxable as a corporation
- Have a board of directors or trustee in place
- Have a minimum of 10 shareholders
- Have no more than 50% of the company held by five or fewer investors
REITs are generally sorted into two major categories, equity REITs and mortgage REITs. There is more information on each below.
More on REITs: REIT Definition: What Is a REIT?