The benefits of real estate investing are the key factor that drives people into this business. But owning an income generating real estate property can be a headache, especially for beginner real estate investors. Moreover, most real estate investments require a large down payment, but as we explained previously, there are some methods where you can invest in real estate with little money. So, is there a way to invest in real estate without going through the troubles of owning, operating and financing a real estate property? The answer is REIT. But what is REIT and how can you profit from it? Is it a good real estate investment strategy? This blog answers the main question crossing your mind now “What is REIT?” and gives you more insight into this passive real estate investment vehicle.
What is REIT?: Overview
A real estate investment trust, or REIT, is a real estate company that owns, manages and finances income-producing real estate properties. REITs were established by Congress in 1960 and since then became a major player in the real estate market, reaching an outstanding market capitalization of $1.1 trillion. REITs are very similar in structure to mutual funds, which allow individual real estate investors to acquire ownership of the company’s assets by buying shares that are publicly traded on major stock exchanges. A major benefit of investing in real estate investment trusts is the access to a diversified real estate portfolio, from residential apartments to hospitals, office buildings, shopping malls, warehouses, etc. However, most REITs specialize in a specific real estate sector.
What is REIT?: Structure
REITs are exempted from income tax on the corporate level, so unlike a typical corporation, a REIT’s income is not taxed, which leaves more money to shareholders. However, investors still have to pay taxes on their dividends. REITs can be either publicly shared and traded, publicly shared but not traded or a private entity. However, it is advisable to not invest in non-traded private REITs because of the complexity of research required on the company and the illiquid nature of the investment.
What is REIT?: Guidelines
In order to qualify as a REIT, a company must meet the following guidelines:
- Pay at least 90% of its income as dividends to shareholders.
- At least 75% of the company’s assets must be invested in real estate, cash or US Treasury bonds.
- At least 75% of the company’s income is from real estate.
- The company should be managed by a board of trustees or directors.
- The company should be jointly owned by at least 100 shareholders.
- No more than 50% of its shares are held by five or fewer investors.
- Be considered as a corporation and IRS revenue code.
What is REIT?: 3 Categories of REITs
1- Equity REITs: When talking about REITs we often refer to equity REITs, which are REITs that invest in income-generating real estate properties.
2- Mortgage REITs: These types of REITs invest in property mortgages by loaning money to real estate investors. They make a profit from the net interest margin.
3- Hybrid REITs: These companies invest in both real estate properties and mortgages.
What is REIT?: How Does a REIT Make Money?
REITs need capital to invest in income-generating real estate properties. REITs seeking capital often find it through IPO (initial public offering), in which they use it to acquire a real estate portfolio. REITs then make money from the real estate properties they purchase by renting, leasing or selling them. The way a REIT makes a profit is called FFO, or fund from operation, which is defined as the net income from renting real estate properties after deducting administration and financing costs.
What is REIT?: Are REITs a Good Investment?
Unlike a traditional real estate investment, you can start investing in real estate investment trusts with very little money. Shares of most publicly traded REITs can be bought for around $200. With those $200 you are already in the real estate investing business. Compare that to directly investing in real estate which typically requires tens of thousands of dollars. Yet, you can put as much money as you want in REITs.
A major benefit of investing in a real estate investment trust is passive income, which is simply money that you don’t have to do much to make it. Forget about the hassle of collecting rent, emergency repairs, and dealing with tenants’ problems.
Investing in REITs is an excellent way to diversify your real estate portfolio and distribute the risk. On the other hand, diversification in direct real estate investing is not easy because of the high price point of buying investment properties.
What is REIT?: How to Invest in REITs
Once you learn “what is REIT”, getting started is very simple. You just need a brokerage account. Then you will be able to buy or sell REIT shares, as simple as buying any other stock. Directly investing in a real estate property which often requires real estate agents, lawyers, and accountants, is not as simple. However, before investing in a REIT, make sure to choose one with a good management team and a proven track record. In addition, always make your decision based on current trends. For example, if the real estate market for suburban malls is in decline then do not invest in a REIT with exposure to suburban malls investments.
The Bottom Line
Indirect investing in real estate through real estate investment trusts can be a great way to generate passive income and can be a less expensive alternative to traditional direct real estate investing. As mentioned above, choose the right REIT based on the company’s track record and current real estate market trends. Now that you know what is REIT, it is time to consider them to diversify your real estate portfolio.
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