3.8. Real Estate Investment Trusts (REITs)
Investing in real estate can provide diversity to a portfolio, regular income, and capital appreciation over time. However, real estate can be an expensive investment, and liquidity can be limited due to fluctuating market conditions. Real estate investment trusts offer investors the opportunity to invest small amounts in real estate and to do it with liquidity.
A real estate investment trust (REIT) is a type of trust that is modeled on a mutual fund. The managers of an equity REIT buy, develop, manage, and sell a portfolio of income-producing properties. Because a REIT is a trust, it sells shares of beneficial interest. The holder of these shares receives benefits from the assets held by the trust—in this case, real estate—but does not own the actual assets. By owning a REIT, investors can take part in real estate’s potential benefits, including price appreciation and income, without the burden of owning and managing property.
REITs can also be mortgage REITs. Rather than purchasing properties, mortgage REITs lend money to developers and make money through charging interest on loans.
REITs are not investment companies. But REITs are a packaged security, and for that reason, they are included in this chapter.
REIT shareholders receive dividends from investment income (primarily rent on equity REITs and interest on mortgage REITs). REIT shareholders also receive capital gains distributions when properties are sold. REITs do not pass through losses to shareholders, unlike a real estate limited partnership (RELP) or a real estate direct participation program (DPP).
To qualify with the IRS, a REIT must meet the following requirements:
- • It must distribute at least 90% of its income to its shareholders.
- • Annually, at least 75% of the REIT’s gross income must be real estate–related income (e.g., rents).
- • Annually, at least 95% of the REIT’s gross income must come from re