Today, an estimated 70 million Americans invest in and own shares of various REITs. This number is only going up as the sector grows and changes rapidly, so we decided to put together a short REIT refresher.
What is a REIT?
A REIT (which is pronounced “reet” and stands for Real Estate Investment Trust) is a company which makes investments in and owns incoming generating real estate properties. Investors buy shares of the REIT and the REIT uses that money to make investments. The REIT then typically earns income from rent payments or interest on real estate debt.
REITs were invented in the United States in 1960 to give average individuals a way to invest in diversified pools of income-producing commercial real estate. REITs gave investors access to real estate in similar way that stocks provide an opportunity to participate in the profits of an operating company. Purchasing shares in a REIT allows investors to earn money from the income produced by properties without having to directly own the property themselves.
How does a REIT work?
REITs are unique because they have to follow a specific set of operating requirements in order to meet REIT qualifications. For example, REITs are required to derive at least 75% of their gross income from real estate-related sources and invest at least 75% of their total assets in real estate. In addition, REITs must distribute no less than 90% of their taxable income every year to their shareholders by paying dividends.
If a REIT meets the qualifications, they are not required to pay taxes at the company level. Only the individual investors pay income taxes for the dividends they receive.
Why does this matter? It means there is no double taxation on the income stream produced by the property (as if it were owned by a traditionally publicly traded company) which means that the investor is able to keep a larger portion of that income stream and earn higher returns.
Types of REITs
There are many different types of REITs and it can be helpful to think about them according to a few different categories. At the broadest level, REITs can be defined by the way that investors are able to access them.
Public vs. Private REITs
Publicly traded REITs are listed on a stock exchange, just like a public company. Public non-traded REITs are registered with the SEC but not listed on a public exchange. Finally, there are private REITs which are not registered with the SEC or listed on an exchange.
Publicly traded REITs offer the benefits of being traded openly on an exchange, giving investors liquidity. However this liquidity tends to be priced into the value of the stock itself through a “liquidity premium”, resulting in lower relative returns for investors who otherwise would be happy to own the shares for the long-term.
The most commonly cited shortcoming of publicly traded REITs is that they are overly correlated to broader market volatility, meaning that the value may fluctuate up or down depending on how the rest of the stock market is doing. This can happen regardless of whether or not anything has actually changed with the underlying properties owned by the REIT.
Non-traded REITs, on the other hand, have grown in popularity because of the perceived consistent double-digit dividends paid to investors. However, these investments have recently come under heavy scrutiny due to the often large up-front fees often charged to investors - and questionable practices around the disclosure of those fees. According to an Investor Bulletin by the Securities and Exchange Commission, up-front fees for non-traded REITs are often times as much as 15% of an individual’s initial investment, which are some of the highest fees charged across the entire financial industry.
Equity vs. Mortgage REITs
REITs can also be bucketed by the nature of the investments they include: equity or debt / mortgages. Most REITs are equity REITs, which participate in the ownership, operation, and development of commercial real estate assets. Meanwhile, mortgage REITs own large pools of real estate debt, their earnings coming from interest payments on this debt.
Equity REITs are further categorized by the types of property in which they invest. This is where REIT strategies really fracture; there are REITs that focus on every type of property imaginable, from apartment buildings to data centers to self storage facilities.
Equity REITs also choose strategies based on how much work is needed to bring their investments to their highest value and potential for producing income. For example, an opportunistic REIT focuses on assets which will need to add value added to them through renovations or development, while other REITs may only acquire fully occupied income-producing apartment buildings. Typically, the greater the amount of work required, the greater the opportunity, but the higher the risk.
The Fundrise eREITs™ are the first-ever online real estate investment trusts. The eREITs™ use a web-based, direct distribution model to offer a low-cost, diversified commercial real estate investment available to anyone, with fundamentally lower volatility and 90% lower costs than traditional REITs. By removing middlemen such as brokers, costs and fees are dramatically reduced. You can find out more about the differences between the Fundrise eREIT™ and other REITs here.