Walker Capital Consulting Group, LLC

 

REITs 101: What is a REIT?

 

A REIT is a company that buys, develops, manages and sells real estate assets. REITs allow participants to invest in a professionally-managed portfolio of real estate properties. REITs qualify as pass-through entities, companies who are able distribute the majority of income cash flows to investors without taxation at the corporate level (providing that certain conditions are met). As pass-through entities, whose main function is to pass profits on to investors, a REIT's business activities are generally restricted to generation of property rental income. Another major advantage of REIT investment is its liquidity (ease of liquidation of assets into cash), as compared to traditional private real estate ownership which are not very easy to liquidate. One reason for the liquid nature of REIT investments is that its shares are primarily traded on major exchanges, making it easier to buy and sell REIT assets/shares than to buy and sell properties in private markets.

 

REITs 101: History of REITs

 

The origins of the real estate investment trust, or REIT (pronounced "reet") date back to the 1880s. At that time, investors could avoid double taxation because trusts were not taxed at the corporate level if income was distributed to beneficiaries. This tax advantage, however, was reversed in the 1930s, and all passive investments were taxed first at the corporate level and later taxed as a part of individual incomes. Unlike stock and bond investment companies, REITs were unable to secure legislation to overturn the 1930 decision until 30 years later. Following WWII, the demand for real estate funds skyrocketed and President Eisenhower signed the 1960 real estate investment trust tax provision which reestablished the special tax considerations qualifying REITs as pass through entities (thus eliminating the double taxation). This law has remained relatively intact with minor improvements since its inception.

 

REIT investment increased throughout the 1980s with the elimination of certain real estate tax shelters. Investments in real estate provided investors with income and appreciation. The Tax Reform Act of 1986 allowed REITs to manage their properties directly, and in 1993 REIT investment barriers to pension funds were eliminated. This trend of reforms continued to increase the interest in and value of REIT investment.

 

Today, there are more than 193 publicly traded REITs operating in the United States their assets total over $500 billion. Approximately two-thirds of these trade on the national stock exchanges.*

 

* Data updated April 2005

 

 

 

REITs 101: REIT classification

 

In order for a corporation to qualify as a REIT and gain the advantages of being a pass-through entity free from taxation at the corporate level, it must comply with the following Internal Revenue Code provisions:

 

• Structured as Corporation, business trust, or similar association
  
  
• Managed by a board of directors or trustees
  
  
• Shares need to be fully transferable
  
  
• Minimum of 100 shareholders
  
  
• Pays dividends of at least 90 percent of REIT's taxable income
  
  
• No more than 50 percent of the shares can be held by five or fewer individuals during the last half of each taxable year
  
  
• At least 75 percent of total investment assets must be in real estate
  
  
• Derive at least 75 percent of gross income from rents or mortgage interest
  
  
• Have no more than 20 percent of its assets consist of stocks in taxable REIT subsidiaries

 

REITs 101: Types of REITs   REITs fall into three broad categories:   Equity REITs: (96.1%) Equity REITS invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties' rents.   Mortgage REITs: (1.6%) Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or invest in (purchase) existing mortgages or mortgage backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.   Hybrid REITs: (2.3%) Hybrid REITs combine the investment strategies of Equity REITs and Mortgage REITs by investing in both properties and mortgages.     Individual REITs are able to distinguish themselves by specialization. REITs may focus their investments geographically (by region, state, or metropolitan area), or in property types (such as retail properties, industrial facilities, office buildings, apartments or healthcare facilities). Certain REITs choose a broader focus, investing in a variety of types of property and mortgage assets across a wider spectrum of locations.   The current REIT industry's investment choices can be broken down by property type as follows: Retail 20.1% Residential 21.0% Industrial/Office 33.1% Specialty 2.3% Health Care 3.8% Self Storage 3.6% Diversified 8.5% Mortgage Backed 1.5% Lodging/Resort 6.1%     Please Note Figures and percentages listed above are from NAREIT, First Quarter 2001.