A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends.
REITs allow anyone to invest in portfolios of large-scale properties the same way they invest in other industries – through the purchase of stock. In the same way shareholders benefit by owning stocks in other corporations, the stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy or finance property.
REITs have existed for more than 50 years in the U.S. Congress granted legal authority to form REITs in 1960 as an amendment to the Cigar Excise Tax Extension of 1960. That year The National Association of Real Estate Investment Funds, a professional group for the promotion of REITs is founded. The following year it changed its name to the National Association of Real Estate Investment Trusts (NAREIT).
In 1965 the first REIT, Continental Mortgage Investors, is listed on the New York Stock Exchange (NYSE). By the late 1960s, major investors, including George Soros, become interested in research on the value of REITs. Mortgage based REITs account for much of the growth of REITs in the early 1970s, and they fuel a housing boom. The boom busts after the oil shocks of 1973 and the recession that follows.
In 1969 the first European REIT legislation (the Fiscal Investment Institution Regime [fiscale beleggingsinstelling: FBI]) is passed in The Netherlands.
Since their development in Europe, REITs have become available in many countries outside the United States on every continent on Earth.
The first listed property trusts launch in Australia in 1971.
Canadian REITs debut in 1993, but they don’t become popular investment vehicles until the beginning of the 21st century.
REITs began to spread across Asia with the launch of Japanese REITs in 2001.
REITs in Europe were buoyed by legislation in France (2003), Germany (2007) and the U.K. (2007). In total, about 40 countries now have REIT legislation.
3 Main Kinds of REITs in the U.S.
1. Equity REITs invest in and own properties, that is, they are responsible for the equity or value of their real estate assets. Their revenues come principally from leasing space—such as in an office building—to tenants. They then distribute the rents they’ve received as dividends to shareholders. Equity REITs may sell property holdings, in which case this capital appreciation is reflected in dividends. Timber REITs will include capital appreciation from timber sales in their dividends. Equity REITs account for the vast majority of REITs.
2. Mortgage REITs invest in and own property mortgages. These REITs loan money for mortgages to real estate owners, or purchase existing mortgages or mortgage-backed securities. Their earnings are generated primarily by the net interest margin, the spread between the interest they earn on mortgage loans and the cost of funding these loans. This model makes them potentially sensitive to interest rate increases. In general, mortgage REITs are less highly leveraged than other commercial mortgage lenders, using a relatively higher ratio of equity to debt to fund themselves.
3. Hybrid REITs invest in both properties and mortgages.
Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. Some REITs are SEC-registered and public, but not listed on an exchange; others are private.
Some REITs will invest specifically in one area of real estate—shopping malls, for example—or in one specific region, state or country. Others are more diversified. There are several REIT ETFs available, most of which have fairly low expense ratios. The ETF format can help investors avoid over-dependence on one company, geographical area or industry.
REITs provide a liquid and non-capital intensive way to invest in real estate. Many have dividend yields in excess of 10%. REITs are also largely uncorrelated with stocks and bonds, meaning they provide a measure of diversification.
Today, REITs are tied to almost all aspects of the economy, including apartments, hospitals, hotels, industrial facilities, infrastructure, nursing homes, offices, shopping malls, storage centers, student housing, and timberlands. REIT-owned properties are located in every state and according to an E&Y study, support an estimated 1.8 million U.S. jobs annually. U.S. REITs have become a model for REITs around the world, and now more than 30 countries around the world have adopted REIT legislation.
To qualify as a REIT a company must:
- Invest at least 75 percent of its total assets in real estate
- Derive at least 75 percent of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate
- Pay at least 90 percent of its taxable income in the form of shareholder dividends each year
- Be an entity that is taxable as a corporation
- Be managed by a board of directors or trustees
- Have a minimum of 100 shareholders
- Have no more than 50 percent of its shares held by five or fewer individuals
REITs offer investors a number of benefits, including:
- Diversification: Over the long term, Equity REIT returns have shown little correlation to the returns of the broader stock market.
- Dividends: Stock exchange-listed REITs have provided a stable income stream to investors.
- Liquidity: Stock exchange-listed REIT shares can be easily bought and sold.
- Performance: Over most long-term horizons, stock exchange-listed REIT returns outperformed the S&P 500, Dow Jones Industrials and NASDAQ Composite.
- Transparency: Stock exchange-listed REITs operate under the same rules as other public companies for securities regulatory and financial reporting purposes.