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Real Estate Investment Trusts 101: REITs Let Passive Investors in on the Action

What do Real Estate Investments Cost- in Sheer Effort?

Savvy investors make real estate part of a diversified portfolio to grow and preserve their wealth. The challenge with many real estate investments, however, is that they can require considerable work to operate and maintain, especially if they involve direct ownership of the property.

But there are some purely passive types of real estate investments that can provide the economic benefits of property ownership without the corresponding management responsibilities. A real estate investment trust (REIT) is one such type of investment.

[REITs] provide the economic benefits of property ownership without the corresponding management responsibilities.

REITs Provide Flexible Investing Choices

Most REITs are equity REITs. This means that they own and typically operate a portfolio of cash-flowing real estate. REITs commonly focus on a specific class of assets that they develop or acquire, and then hold for profit during the life of the fund.

For example, REITs may concentrate on industrial properties, medical office buildings, shopping centers or student housing. Other equity REITs focus on a geographic region, and have greater diversity among asset types in that location. Equity REITs’ goal is to generate cash flow by leasing the real estate, and to increase investor value through appreciation.

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Besides equity REITs, there are also REITs that invest in and own real estate mortgages, mortgage-backed securities and other types of loans collateralized by real estate. Mortgage REITs make profits by borrowing at lower, short-term interest rates and buying mortgages at higher long-term rates; the profits are comprised of the spread between these rates. Because interest rates and the corresponding spreads fluctuate constantly, mortgage REITs are generally a riskier investment than equity REITs.

There are also hybrid REITs, which invest in both mortgages and leased real estate.

Who Juggles the Balls in the Air?

REITs and the underlying properties they own are professionally managed. Major decisions such as acquisitions, financing, leasing and dispositions, are made by a board of directors or trustees, made up of industry and financial professionals. Individual investors in a REIT do not have a voice in property or asset management, financing or disposition. They also do not have any choice about the specific properties owned by the real estate investment trust.

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REITS can be privately held or publicly traded as securities on major exchanges. Public REITs function similarly to a mutual fund of real estate interests. Thus, publicly traded REITs provide a degree of liquidity not generally available for direct real estate investments or private syndications. Real estate investments involving private REITs are usually available through licensed securities brokers specifically authorized to sell the offerings. These investments are not necessarily liquid, and their maturities depend on the timing of the REIT’s disposition of the underlying assets.

REITs Must Comply with Specific Legal Requirements

REITs are legally required to:

  • distribute 90% of their taxable income to their investors on an annual basis;
  • invest at least 75% of their total assets in real estate, cash, or U.S. treasuries;
  • receive at least 75% of their gross income from rents from real property, interest on mortgages financing real property, or from sales of real estate; and
  • have at least 100 shareholders/investors, with no five shareholders owning more than 50% of the shares.

Are the Advantages of Investing in REITs Right for Your Money?

There are many reasons why investing in a REIT may be beneficial to you:

  • Real estate investments via REITs allow you to invest in a diversified real estate portfolio without any property or asset management responsibilities, and without any personal liability for financing. The work of due diligence, acquisition and disposition are all done for you.
  • The underlying assets of a REIT tend to be institutional quality, and of greater size than individuals can typically afford to acquire on their own.
  • Properties owned by REITs are professionally managed by people with quantifiable experience and track records in commercial real estate.
  • Publicly traded REITs have easy liquidity. Shares can be bought and sold readily on public exchanges. Financial reporting is provided on a regular basis as required by the SEC, and can be viewed online.
  • Many REITs are industry-specific. This allows you to concentrate your real estate investments in a preferred asset class (e.g., medical office, apartments, industrial).

Disadvantages of Investing in REITs

In spite of the advantages, REITs are not an ideal option for every investor. Here are a few things to be aware of:

  • The “load” (administrative fees and costs) tend to be higher for REITs than for other types of real estate investments. Expect your purchase price to include fees to REIT management and its board of trustees, management at the property level, and brokers who offer the REIT interests for sale. You will also share annually in the cost of a full audit by a nationally recognized accounting firm, in addition to the expenses of issuing annual tax reporting documents for individual investors. Outside professionals engaged to provide transactional services for REITs, such as attorneys, are typically members of larger firms with well-established national or international practices, with fees at the higher end of the pay scale.
  • Private REITs may not have the same degree of liquidity as publicly traded ones.
  • Individual investors do not have any say in choosing the underlying properties or their ongoing management, financing, or disposition.
  • Interests in REITs are considered securities rather than fractional ownership of real property, and interests in REITs cannot be used as replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code.

As with any investment, it is wise to consult with your financial advisor to decide whether an investment in a REIT may be beneficial to you.

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About Tracy Treger

Tracy is a Principal at Syndicated Equities where she helps high net worth individuals and family offices to profitably invest in real estate. She also assists investors in identifying appropriate replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code. Drawing upon her 20 years of legal experience in the areas…

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