Finance October 26, 2015 Last updated September 18th, 2018 635 Reads share

Investing In Real Estate Investment Trusts

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Real Estate Investment Trusts,

Real Estate Investment Trusts – History and Criteria

The REIT began in 1960, when the government allowed smaller investors to participate in the benefit of owning large pieces of real estate for the purpose of income production. The main idea is in purchasing equity. In order to be a REIT, a corporation must meet the following criteria:

  • Have shares that are fully transferable
  • Have a board of directors as management
  • Have a structure like a corporation or similar
  • Possess a minimum of 100 shareholders
  • Be able to pay a minimum of 90 percent dividends on the taxable income
  • Have less than half its shares held by less than five people during the last half of a tax year
  • Have a minimum of 75 percent of its assets in real estate
  • Produce a minimum of 75 percent of gross income from real estate sources such as rent or interest

There are several different types of Real Estate Investment Trusts spread throughout three main categories. The three categories of REITs are:-

  1. Equity REITs,
  2. Hybrid REITs.
  3. and Mortgage REITs.

Equity Real Estate Investment Trusts

Equity REITs, or EREITs, own large business complex real estate such as malls, apartment complexes and office buildings. They purchase and manage these properties specifically to generate income in a portfolio, as opposed to purchasing for resale. Long-term investors may want to look at EREITs due to their superior potential for income through several sources.

Mortgage Real Estate Investment Trusts

Mortgage REITs, or MREITs, loan mortgage money instead of investing in real estate property. They may loan money to those looking to purchase real estate, or they may buy mortgages or securities backed by mortgages. Revenue is typically produced through interest on the mortgages. MREITs are more quickly affected by interest rate changes because of this.

As of 2015, there are about 40 MREITs, and of these, slightly over half are into securities from residential mortgages, while the rest are into commercial. They are especially attractive as a speculative investment when rates are low or expected to drop.

Hybrid Real Estate Investment Trusts

Hybrid REITs, or HREITs, combine the the other two types of Real Estate Investment Trusts. They purchase and own property and they also offer loans to property owners and managers. These REITs consequently derive income from both interest and rent. Certain types may have a fixed time limit, having been created for a specific project. Once that project is completed, the REIT is dispersed and any profits are distributed among the shareholders.

Funds from Operation (FFO)

REITs operate with external funding to fuel their capital. Investors own a portion of the pooled investments. The income comes from the renting, buying and selling of real estate properties and is then transferred to the holder on a consistent time table. The income is equally distributed among the number of shareholders.

Real estate investment trust income is calculated through funds from operation (FFO). The National Association of Real Estate Investment Trusts allows FFO to include net income through property sales. It excludes property sales with either losses or gains.

Funds from operation is designed to keep track of a REIT’s income flow from real estate properties, while deducting financing and managerial costs. The net income assumes asset value decreases over time with a consistent trend. However, real estate typically keeps value or increases in value. According to general accounting principles, land stays the same, while structures eventually depreciate to nothing. Because the main focus of a REIT’s business is real estate, the FFO system was developed to exclude depreciation.

Smart financing and taxes

However, funds from operation is not completely airtight. It is generally recommended that investors look at quarterly reports to get a better idea of a REIT’s capital and any other expenses. Since they are usually publicly traded, they give investors a great opportunity to diversify and balance their portfolio. They can give investors the chance to earn long-term income through dividends and capital gains.

They further have an advantage over most other stock types because of the pass through taxes. As long as the REIT continues to pay out 90 percent of its income to shareholders, it continues to not be taxable. Because of that, shareholders get even more of the earnings without the cut from taxes.

Inflation resistance

REITs are also notable for decent inflation resistance and a consistent revenue flow. Because many if them derive income from rent, they are automatically adjusted for cost of living and thus for inflation. The main disadvantages of REITs are the lack of eligibility for a 15 percent tax rate on dividends that came into being in 2003. This translates to investors having to pay as much as 35 percent for the general income tax. Distributions that are not taxable, are then taxed like capital gains. This can be as much as 15 percent.

Conclusion

Real estate investment trusts as a property investment trust, typically require much less time and energy spent vs purchasing various real estate property. That said, good research is a must for any investor looking to get into them.

Real estate training or a real estate license course might come in handy for researching REITs. Choosing a REIT involves many factors, including the investor’s own needs and the management of it. Investors should be wary of REITs with very high yields. This may indicate income from temporary sources, which will not continue in the future. It is also good to make sure that it is not deriving income from only selling properties as this hampers future rental income.

Images: “Real Estate word on newspaper /  Shutterstock.com

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Tully Rickets

Tully Rickets

Tully Rickets is a life long traveler and inspirational writer from Australia with interests in business and new technologies. When he's not blogging about business or technology, he enjoys researching ideas for his book. He has been learning a lot by reading many informative posts from many online resources.

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