Savvy investors know that real estate-based holdings are an important part of a diverse portfolio. Unfortunately, real estate investment can be a lot of work, especially researching the best places and types of real estate holdings to invest in. Even more difficult, the cost to finance a new hospital or apartment complex can be prohibitive for many investors. That’s why real estate-based securities like REITs can offer an appealing alternative—a way to invest in real estate in a more liquid, less research-intensive way.
While REITs may require less real estate knowledge than straightforward real estate investment, REITs are still a security with the same risks as any other share purchase deal. In order to ensure that you are investing in a reputable REIT and executing all contracts properly, you should discuss the specifics with a lawyer who has experience with REITs. Through Priori's vetted marketplace, you can connect on-demand to a lawyer who has the relevant experience and expertise.
Real estate investment trusts (REITs) are investment vehicles for real estate. Akin to mutual funds, these securities provide investors a liquid way to diversify an investment portfolio through property-based holdings.
How REITs Work in the U.S.
REITs have been an investment option in the U.S. since 1960. REITs usually are structured as corporations with large real estate holdings. People then buy shares of the corporation just like they would buy shares of any other company. In turn, the revenues of rents and mortgages of the properties are disbursed to shareholders.
REITs are a type of security with revenues that must be at least 75 percent derived from real estate, either from physical properties or mortgages. In the U.S., REITs must have at least 100 shareholders, no five of whom hold more than 50 percent of shares altogether. Unlike many corporate securities, REITs must maintain dividend payout ratios of at least 90 percent by law. This can make REITs an appealing option for income-seeking investors.
Types of REITs
REITs come in many forms. They can be publicly or privately traded, and can be made up of many types of real estate holdings. There are four basic types of REITs that U.S.-based investors have access to:
- Equity REITs: Equity REITs own and invest in actual physical properties. The revenues from these REITs come primarily from the revenues of renting or leasing the properties owned, but some revenues can come from selling resources derived from the real estate, such as timber. Equity REITs are by far the most common type of REIT.
- Mortgage REITs: Mortgage REITs own and invest in the mortgages of real estate holdings. Such REITs either loan money directly to property owners for mortgages or purchase existing mortgages and mortgage-backed securities. Revenues from these REITs come from the interest earned off the mortgages.
- Hybrid REITs: Hybrid REITs use a combination of equity-based revenues and mortgage-based revenues to make the REIT profitable for investors.
- International REITs. While most international REITs are formed similarly to those in the U.S., REITs abroad are subject to different laws and taxation, which can seriously impact the returns expected. Before you invest in an international REIT, it’s important to discuss the legal issues involved with REITs in that country with an investment and international tax lawyer.
Advantages and Disadvantages of REITs
There are many advantages of REITs, but there are two primary advantageous reasons that people like to invest in REITs. First, REITs tend to have high yields for investors, as 90 percent of all REIT income must be paid out in dividends to investors and the physical assets associated with RIETs tend to appreciate over time. Secondly, REITs offer investors a way to diversify their holdings through real estate without the hassles, illiquidity and large initial investments usually required for real estate investment.
There are, however, some disadvantages to REITs. First, if property values drop, share prices take a similar dip. In addition, vacancies in properties or falling occupancies can seriously hurt equity REITs, while defaults can hurt mortgage REITs. Finally, rising interest rates hurt REITs, which make their success somewhat dependent on the state of the economy.
The cost of hiring a lawyer with experience in REITs can vary significantly, depending on a variety of factors. Priori lawyers can guide you through the investment from approximately $250 to $450 per hour. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and free price quote from one of our lawyers.
What’s the difference between REITs and commodity pools?
While similar, since both are based on revenues from physical assets, REITs are based primarily on the revenues from the properties themselves through rents and mortgages, and commodity pools are based primarily on the revenues from selling the natural resources and goods derived from any properties owned by the pool.
How are REITs taxed?
Generally, dividends from REITs are taxed at the lower capital gains rate, not as personal income. That said, some returns from REITs will not qualify as capital gains and hence, will be taxed at a higher rate.