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What Are Real Estate Investment Trusts (REITs)

A real estate investment trust (REIT) purchases, operates or finances income-producing real estate. Most REITs are modeled after mutual funds—where several investors pool funds—and publicly trade like stocks. REITs make it possible to invest in commercial real estate investments without buying a building yourself. 

🤔 Understanding REITs

Congress established the legal structure for REITs in 1960 to bring retail investors into the world of commercial real estate. REITs benefit from a legal structure that does not have corporate taxes, avoiding double taxation. The only taxes are those paid by investors in the REIT on distributions received.

REITs own or finance a variety of income-producing real estate, including apartment and office buildings, retail centers, healthcare facilities, and even cell towers. 

Generally, you can divide REITs by their investment practices:

  • Equity REITs make up the bulk of the REIT market. They own and manage income-producing real estate, such as leased office space. 
  • Mortgage REITs fund or invest in real estate loans, mortgages and mortgage-backed securities. They generate income by collecting interest on loans. 
  • Hybrid REITs invest in both income-producing real estate and real-estate backed securities and loans.

How do REITs work?

Unlike some “regular” real estate companies, REITs don’t develop or flip property. But they do tend to share a similar business model:

  • The trust leases space to tenants or finances properties owned by others
  • The trust collects rent or interest payments
  • Shareholders receive dividends out of the profits

What qualifies as a REIT?

The Internal Revenue Code places strict regulations on what does and doesn’t qualify as a REIT. Among other qualifiers, a trust must:

  • Invest at least 75% of its assets in cash or real estate
  • Derive at least 75% of income from rent, sales or mortgage interest
  • Pay at least 90% of its taxable income to shareholders

Additionally, the trust must be structured as a taxable corporation and properly managed by a board of directors or trustees. 

Investing in REITs

You can invest in three basic types of REITs:

  1. Publicly traded REITs list on national securities exchanges and must register with the SEC. If you have a brokerage account, you can invest in publicly traded REITs. 
  2. Public non-traded REITs register with the SEC but don’t trade on national exchanges. Your broker may be able to connect you with non-traded REITs. While they can be more stable than listed REITs, they may also provide less liquidity. 
  3. Private REITs don’t list on national exchanges or register with the SEC. Generally, only institutional or high-net-worth investors can buy into private REITs. 

What this means for you

REITs can boost your investment returns by providing stable annual income. For the most part, they’re easy to buy and sell, as they’re usually more liquid than physical real estate.  

As an investor, you can buy into regular REITs, REIT mutual funds or even REIT ETFs through your broker. Doing so helps diversify your investments, boosts your dividend income, and of course, lets you buy into real estate without actually buying real estate. 

However, REITs don’t often offer much in the way of short-term capital appreciation, as the bulk of their taxable income goes to investors. Also, REITs can make for expensive investments thanks to high management and transaction fees. Plus, any dividends you receive are typically taxed as regular income. 

You should also watch out for fraudulent investments. While legitimate private REITs do exist, generally, the SEC cautions against buying REITs that aren’t registered with the SEC.

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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