Real Estate Investment Trusts invest in properties, offering diversification benefits of an asset class different from stocks, bonds, and commodities.
Investing in REITs is an easy way to bet on real estate, including commercial properties
How REITS work
Common funds that invest in real estate and mortgages are Real Estate Investments Trusts (REITs). These give an investor an ability to invest in real estate without becoming a landlord. These funds invest in a variety of real estate including residential, commercial/industrial, and self-storage properties.
REITs purchase and operate various income-producing properties such as hotels, shopping centers, hospitals, warehouses, and office buildings. REITs can also specialize in other real estate types. Among these types, there are retail, residential, office, and industrial REITs.
Among the major kinds of Real Estate Investment Funds are Equity and Mortgage REITs. Equity REITs invest in properties and rely on rental income, while Mortgage REITs lend money to borrowers or purchase existing mortgages. In addition, some companies operate Hybrid REITs that combine both types.
How to invest in REITs
Typically, REITs are traded on a stock exchange (although there are non-traded kinds as well). This makes it easy to buy shares with a plain online brokerage account. Another plus is that the investments in REITs are liquid, meaning REITs produce income for their shareholders and are easier to sell.
How REITS are taxed
In order to qualify as a Real Estate Investment Trust in the United States, these trusts need to distribute at least 90% of their taxable income to investors. Otherwise, the trusts would be taxed as corporations. (There are additional requirements related to the percentage of assets invested in real estate, number of shareholders, and so on.)
The distributions to the shareholders are in the form of dividends. Effectively, investors, not REITs, pay taxes, and usually at lower rates than the corporate tax rate. On top of it, investors may get a return on capital invested, which is deferred (non-taxable at the time of distribution) until REIT shares are sold. At that time, it becomes a capital gain (or loss).
Effectively, a purchaser of these assets receives a dividend income and retains the potential to gain from real estate appreciation. On the other hand, this investment can also lead to losses if real estate market turns down as in 2008. To qualify as a REIT, the fund must pay at least 90% of its taxable income in dividends. These funds are usually structured as corporations or trusts.
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