What You Should Know About REITs
REITs (Real Estate Investment Trusts) were first allowed for in the United States in 1960 when President Eisenhower signed into law the REIT Act. This act gave investors the option to invest in income producing real estate in the same manner as other types of assets. A REIT is any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages. It avoids most or all of their tax liabilities by deducting the dividend it pays to its owners. REITs typically owns, and in most cases, operates income-producing real estate. REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels and even timberlands.
To qualify as a REIT under U.S. tax rules, a company must:
- Be structured as a corporation, trust, or association
- Have transferable shares or transferable certificates of interest
- Pay dividends of at least 90% of the REIT’s taxable income
- Have no more than 50% of the shares held by five or fewer individuals during the last half of each taxable year (5/50 rule)
- Have at least 75% of its total assets invested in real estate
- Derive at least 75% of its gross income from rents or mortgage interest
- Have no more than 25% of its assets invested in taxable REIT subsidiaries.
- Otherwise be taxable as a domestic corporation
- Not be a financial institution or an insurance company
- Be jointly owned by 100 persons or more
- Have 95 percent of its income derived from dividends, interest, and property income
- Be managed by a board of directors or trustees
Unlisted, or non-traded, REITS differ from listed REITs in that they are not traded on an open market. Rather, non-traded REITs are sold to investors who then hold the product until the end of an investment term.
The value of a non-traded REIT is set by the very companies which sells it. Unlike a listed, or public, REIT which is valued daily based on the market in which it is traded, a non-traded REIT’s value is determined by the staff of the REIT, or sometimes by a third party consultant paid for by the REIT.
Non-traded REITs also force investors to sell their shares through the REIT’s own procedure. The usual procedure is to sell shares through a redemption program, however, many such programs have been suspended due to adverse financial conditions when many investors attempt to redeem their shares at once. The consequence to investors is that they are stuck in the investment until the redemption program is reinstated.
Brokers should be wary of which REITs they recommend to their customers. There is considerable due diligence that a broker needs to conduct before they can reliably recommend a particular REIT to a customer. Often REITs generate a high commission for the broker so this can be an even greater temptation to push REITs on customers. Unfortunately, as the late 2000s financial crisis taught us, property can be just a volatile as a regular security and can be tougher on an investor’s portfolio as their inherent illiquidity can make them tough to impossible to sell.
To learn more about Richard Frankowski, visit The Frankowski Firm.
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