A Real Estate Investment Trust (REIT) is an organization that engages in financing and investing in real estate directly, either through mortgages or properties thus generating a high level of income, diversification and long-term capital appreciation for investors. This article educates us on the function of REITs.
REITs can be public, private and non-listed but most REITs are listed on major stock exchanges thus giving individuals the opportunity to invest in some of their portfolios, especially large-scale properties through the purchase of stock.
This makes such individual shareholders and allows them to earn a percentage of the income realized from the real estate investment, without directly going out to purchase a property.
REITs are modeled after mutual funds in terms of receiving special tax considerations. This is because the fundamental part of the original REIT legislation mandates that all taxable income should be paid as dividends to shareholders after expenses have been deducted from corporate taxable income.
In turn, shareholders are expected to pay the income taxes on the dividends. The dividend distribution is done this way to ensure that REITs continue to deliver the expected income and perform at the standard characteristic of real estate debt and equity investment, as well as to guarantee that investors get the appropriate and approximate investment return if they owned the properties directly.
There are two major types of REITs which are Mortgage REITs and Equity REITs, thus giving investors the option of investing in either the debt financing or the equity financing of real estate.
Some REITs however combine the strategies of Equity and Mortgage REITs by investing in both properties and mortgages. These REITs are referred to as Hybrid REITs.
Mortgage REITs principally invest in commercial and/or residential real estate mortgages and mortgage-backed securities. They operate by providing finance in terms of a loan to mortgage owners of real estate or by buying existing mortgage-backed securities thus making profit through the sales of the mortgages or the interest earned from these investments.
Profit is however announced after funding costs to buy mortgage investments and all other costs have been deducted from the income.
Equity REITs invest in and purchase properties consequently making them responsible for the value or equity of their real estate assets.
Usually, they invest in commercial properties such as shopping malls, apartment buildings, office buildings etc. and lease these structures out to tenants thereby making income through the collection of rent and sales of properties they own for the long-term. Equity REITs pay out on a yearly basis, the bulk of the income they make to their shareholders as dividends and sometimes, the dividends paid is inclusive of capital appreciation from the sale of properties.
REITs are expected to have certain attributes or characteristics in their mode of operation and investments which are income, transparency, diversification, liquidity, investment performance and inflation protection
Income: REITs income is reliable because it is obtained from interest paid from the financing of properties or rents paid by tenants who sign leases for long periods of time.
Transparency: REITs investments have market transparency because its assets are real, tangible and can be easily identified and valued independently. Investors can see, touch and live in these assets. REITs investments also have tax transparency since they are required by law to distribute at least 90 percent of their taxable income. As a result, investors receive returns that are solely on the real estate and not tied to any tax minimization activities.
Diversification: To reduce overall risk, diversification in investments is important and REITs offer this by taking advantage of both public and private investment in real estate thus giving investors the opportunity to have a broad variety of investment alternatives for their real estate allocations.
Liquidity: REITs makes investing in real estate easy and efficient since equities of companies that own portfolios of properties or engage in real estate financing are bought and sold on major stock exchanges. Because of their liquidity nature, REITs have become the most proficient way for investors and investment managers all over the world to gain exposure to commercial real estate
Investment Performance: REITs, Equity REITs give investors capital appreciation prospects especially when investments are held on a long term basis
Inflation Protection: REITs are good protection from inflation especially for commercial real estate investors since rents tend to increase when prices do.
REITs are good investment plans since they provide a high level of income and offer several advantages not found in companies across other industries. These benefits are part of the reason they have become increasingly popular with investors over the past several decades.
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