A REIT is a type of security that makes investment in real estate through property or mortgages and often trades on major exchanges like a stock. REITs provide investors with an extremely liquid stake in real estate. They receive special tax considerations and typically offer high dividend yields.
REIT can be compared with mutual funds that allow both small and large investors to acquire ownership in real estate ventures, own or operate commercial properties such as apartment complexes, hospitals, office buildings, timber land, warehouses, hotels and shopping malls.
All real estate investment trust must have at least 100 shareholders and no five of whom can hold more than 50% of shares between them. At least 75% of a REIT’s assets must be invested in real estate, cash or the Treasurys and 75% of gross income must be derived from real estate.
According to the law, the trust is required to maintain dividend payout ratios of at least 90%, which makes it favorable for income-seeking investors. REITs can deduct these dividends and avoid most or all tax liabilities, though investors still pay income tax on the payouts they receive. Many REITs have dividend reinvestment plans (DRIPs), that allow returns to compound over time.
REITs have existed for more than 50 years in the U.S. Congress granted legal authority to form REITs in 1960 as an amendment to the Cigar Excise Tax Extension of 1960. That year The National Association of Real Estate Investment Funds, a professional group for the promotion of REITs is founded. The following year it changed its name to the National Association of Real Estate Investment Trusts (NAREIT).
In 1965 the first REIT, Continental Mortgage Investors, is listed on the New York Stock Exchange (NYSE). By the late 1960s, major investors, including George Soros, become interested in research on the value of REITs. Mortgage based REITs account for much of the growth of REITs in the early 1970s, and they fuel a housing boom. The boom busts after the oil shocks of 1973 and the recession that follows.
In 1969 the first European REIT legislation (the Fiscal Investment Institution Regime is passed in The Netherlands.
Since their development in Europe, REITs have become available in many countries outside the United States on every continent on Earth.
The first listed property trusts launch in Australia in 1971.
Canadian REITs debut in 1993, but they don’t become popular investment vehicles until the beginning of the 21st century.
REITs began to spread across Asia with the launch of Japanese REITs in 2001.
REITs in Europe were buoyed by legislation in France (2003), Germany (2007) and the U.K. (2007). In total, about 40 countries now have REIT legislation.
3 Main Kinds of REITs in the U.S.
- Equity REITs invest in and own properties, that is, they are responsible for the equity or value of their real estate assets. Their revenues come principally from leasing space—such as in an office building—to tenants. They then distribute the rents they’ve received as dividends to shareholders. Equity REITs may sell property holdings, in which case this capital appreciation is reflected in dividends. Timber REITs will include capital appreciation from timber sales in their dividends. Equity REITs account for the vast majority of REITs.
- Mortgage REITs invest in and own property mortgages. These REITs loan money for mortgages to real estate owners, or purchase existing mortgages or mortgage-backed securities. Their earnings are generated primarily by the net interest margin, the spread between the interest they earn on mortgage loans and the cost of funding these loans. This model makes them potentially sensitive to interest rate increases. In general, mortgage REITs are less highly leveraged than other commercial mortgage lenders, using a relatively higher ratio of equity to debtto fund themselves.
- Hybrid REITs invest in both properties and mortgages.
Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. Some REITs are SEC-registered and public, but not listed on an exchange; others are private.
Some REITs will invest specifically in one area of real estate—shopping malls, for example—or in one specific region, state or country. Others are more diversified. There are several REIT ETFs available, most of which have fairly low expense ratios. The ETF format can help investors avoid over-dependence on one company, geographical area or industry.
REITs provide a liquid and non-capital intensive way to invest in real estate. Many have dividend yields in excess of 10%. REITs are also largely uncorrelated with stocks and bonds, meaning they provide a measure of diversification.