721 UPREITs: Just an off-ramp for your 1031 exchanges – or a wealth-preserving strategy in its own right?

Among tax shields for wealthy individuals and families, 1031 exchanges hold a time-honored status. By reinvesting the proceeds of a real estate sale into a like-kind property, you can delay paying capital gains taxes on it for a very long time – theoretically, forever.

At some point, though, you might want to actually realize that capital gain – trade in that growing portfolio for a robust cash stream. That’s where the Section 721 Umbrella Partnership REIT comes into play. While 1031 exchanges allow deferral of capital gains, at some point, investors may want to transition to a more liquid, diversified structure. An UPREIT enables you to convert your property into operating partnership units, which we’ll explain in a moment. This switchover not only monetizes your holdings, but it puts an end to the constant paperwork and reporting requirements of the 1031 exchange game.

But is that all there is to UPREITs? Are they just the last link in your chain of 1031 exchanges once you choose to retire from actively managing your own real estate holdings? Or are there other use cases for them? We believe there are.

To find those use cases, though, let’s first review how UPREITs work, what favorable tax treatment they convey and who stands to benefit most from employing them.

How UPREITs work

REITs have been around since 1961, but it wasn’t until 1992 that OP units were enabled by federal statute. That would be the previously referenced Section 721 of the applicable part of the Internal Revenue Code: “No gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.”

OP units are ownership interests in the operating partnership of a REIT, which function similarly to shares but have different liquidity and tax characteristics. In other words, they are proportional ownership interest in the operating partnership, as opposed to the REIT itself.

UPREITs differ from traditional REITs in two ways, according to REIT guide author Stephanie Krewson-Kelly. An UPREIT is a REIT that holds its properties through an operating partnership (OP) structure. This allows property owners to contribute real estate tax-deferred in exchange for OP units, instead of selling for cash.(The OPs are called “umbrella partnerships” by regulators, thus the UP in UPREIT.) Second – and this is the key point of distinction for many investors UPREITs can acquire property by exchanging OP units as well as through cash or common stock.

These structures look like this:

In this picture, you’d be one of the affiliates off to the right – those who sold their real estate holdings to the UPREIT. OP units are the usual currency of exchange because of their tax advantages; such a transaction is considered tax-deferred under Section 721, so the property owner need not immediately pay capital gains taxes on the property transfer.  Still, you might elect to take a portion in cash or other consideration. Consult a tax professional to understand how these tax implications may apply to your situation

To become an affiliate, you must contribute your property. As with any real estate transaction, it’s a negotiation and the usual advice applies. This starts with knowing the value of the property you hold via market analysis and appraisal. But that’s the easy part; you’ve probably done it a hundred times. But you were doing it for cash, and OP units are most certainly not cash.

First of all, OP units are far less liquid, and it’s your job to figure out just how much less liquid and discount their value accordingly. If the UPREIT has a mandatory lockup period, that’s a need-to-know. Kiplinger’s reports that such is the norm, and these periods typically run from 12 to 24 months.

And don’t assume a listing on a major stock exchange is irrevocable.

“Because the [UP]REIT could be delisted from the exchange on which [its] Shares are traded, there might be little or no liquidity for the … Shares issuable upon exchange of redeemed OP Units,” cautions a panel of partners from the century-old law firm Vinson & Elkins.

The V&E partners further cautioned that liquidity could be reduced even further “due to insider trading prohibitions or the short swing profits rule of Section 16 of the Securities Exchange Act of 1934”. In a nutshell, that means if you end up with 10% or more of the UPREIT’s equity or accede to the board or top management team, you can’t reverse your exposure to the company for six months, according to the National Association of Stock Plan Professionals.

You should also be aware of when OP units can be – or must be – converted into publicly traded REIT shares, and what the formula for that conversion would be; typically it’s 1:1, but you should nail that down. This lack of liquidity, though, is a feature rather than a bug. It’s what makes the IRS receptive to the idea of deferring the capital gains; if you could easily trade OP units, the tax authorities would be more likely to consider it a cash-equivalent deal and require you to realize your gain. The longer you hold OPs as opposed to REIT shares, the longer your investment remains tax-shielded. Again, you should consult a tax professional to understand how all this may apply to your unique situation.

Second, while you hope and expect them to appreciate relative to cash, there’s no guarantee that they in fact will. You’ll need to quantify the degree of risk you’re taking because your participation with this UPREIT will likely outlive you and be passed down to your inheritors.

Nor are OP units entirely analogous to shares of stock. While they are economically similar, they don’t automatically convey any voting rights. In this way, they’re more like limited partnerships than like other REITs. If you’re accustomed to having a say in the governance of your property, you might want to bear this in mind as you negotiate.

There’s a twist on the UPREIT you should be aware of. Someone with a love of either wordplay or quantum physics named it the DownREIT. These were typically a legacy REIT that wanted to convert to an UPREIT structure but found it too costly or complicated. Instead, it would become a DownREIT by acquiring the portfolio of one specific affiliate and managing it separately from the rest of its assets. This allows these more established REITs to compete with UPREITs as they strive to acquire new properties.

A DownREIT, then, is a facility through which a REIT assists real estate owners in retaining control of their current real estate. According to academic site WSO, investors can negotiate for the REIT to agree to a standstill or lockout agreement once it’s time to sell the contributed assets.

UPREIT benefits

The immediate benefit of an UPREIT is the steady cash flow. Rather than the boom and bust of the real estate market, you now get to kick back and get your distributions, typically on a quarterly or monthly basis. That’s actually a benefit of UPREITs over 1031 exchanges, which you have to keep juggling to defer taxes on your capital gains.

Speaking of tax deferral, that is of course the next important benefit of an UPREIT. Once you transfer your holdings to the OP,  the arrangement protects your capital gains as long as you hold OP units rather than REIT shares. This is much the same arrangement as a 1031 exchange, through which you reinvest the proceeds of the sale of your assets and buy fractional equity shares of a Delaware statutory trust, which owns and operates its own properties. As always, a tax professional is best positioned to help you understand how the implications for your own situation.

DSTs are also frequently used in tandem with UPREITs, again according to Kiplinger’s, particularly some DSTs allow investors to transition into an UPREIT through a 721 exchange, but the timing varies. Many REITs enforce a multi-year lock-in period before allowing this conversion. Essentially, the DST-to-UPREIT path boils down to a three-step process:

  1. The investor enters a DST via 1031 exchange.
  2. The DST provides an option to transition the assets into an UPREIT.
  3. The investor accepts OP units in the UPREIT, completing the 721 exchange.

This path ensures that the like-kind rules are scrupulously followed. It also enables real estate investors with a modest portfolio to rinse-and-repeat until they have accumulated enough to make a 721 exchange worthwhile; that’s typically somewhere around $30 million in assets.

One main difference between an UPREIT and a DST is that the UPREIT tends to offer much greater diversification. You are essentially commingling your holdings with those of other investors in similar situations. This of course minimizes the risk of the overall portfolio. DSTs tend to be the ownership and management structure of a single property or tight cluster of properties.

Another difference is liquidity. Again, the only reason why either of these options is tax-advantaged is because they are by nature illiquid. That said, at least OPs can be converted into UPREIT shares, which are readily tradable. Ideally, you wouldn’t want to make that conversion during your lifetime but, once your legacy has been passed forward, each beneficiary can decide individually whether or when to cash out.

Estate planning is very much part of an UPREIT’s appeal. To start with, OPs or UPREIT shares are a lot more fungible than property deeds. Further, your heirs’ tax basis for the assets would be their fair market value on the day of your passing rather than their value on the day you entered into the 721 exchange. Assuming the assets appreciated, that’s a tax advantage you can leave to your loved ones – the degree of which is best left to a tax professional to calculate.

And let’s not forget the reason for any investment: returns. Even before the tax shielding, an UPREIT ought to present superior financial benefits to your standalone real estate investment. You should also consider fees and commissions; UPREITs tend to be more efficient than DSTs, but there’s no guarantee. If the vehicle you’re contemplating has not historically outperformed both before and after tax and fee considerations, that might be a signal to choose a different one.

Potential downsides

You can’t outrun the IRS forever, just until you die. When you or your inheritors convert your OPs into UPREIT shares, you must pay taxes on those capital gains.

You might incur other taxation. First, your distributions will be taxed as regular income. While you might not be crazy about the idea of paying 20% of your windfall upon realizing your capital gain, let’s remember that the distributions will probably be levied at a higher rate. You won’t experience the same sticker shock because the income will be spread out over years, but we shouldn’t fool ourselves.

There may be a way out, though. OP or UPREIT distributions may be classified as a return of capital, deferring immediate taxes. However, this reduces the tax basis of OP units, potentially increasing capital gains taxes when they are eventually sold.

If your net worth is greater than around $14 million – and, if you’re looking at UPREITs, it probably is – you face the spectre of the estate tax. Unless you’re survived by an inheriting spouse, your estate will get hit with a 40% marginal tax rate. Suddenly, the 20% rate of the capital gains tax doesn’t look so usurious, but you should get the opinion of a tax professional when making such comparisons relative to your own portfolio.

As we discussed before, you lose direct control over your property when you enter into a 721 exchange, but that is not, strictly speaking, an economic imposition. More critical is the market risk. You went into real estate in the first place because it has such a strong tendency to appreciate in value, but nothing is for certain. There is always market risk. Not only could you find yourself selling into a recessionary environment, the underlying properties could become less valuable. Even if the land itself constantly rises in value, the buildings occupying it are constantly depreciating in both accounting and real-world terms. There’s no guarantee that the OP units you traded your property for will mature into even more valuable UPREIT shares.

UPREITs are, of course, subject to the same stresses as any other business, so you should pay particular attention to its debt. A high debt-to-equity ratio, above-average exposure to variable interest rates and a tendency to borrow money to pay distributions are all red flags.

Let’s also not lose sight of the cost of doing business.

Finally, there’s “finally”. The UPREIT is the end of the road for deferring capital gains. There are no more like-kind exchanges to be made once you pull the trigger on a 721 and transfer your holdings directly into an UPREIT. If you’re closer to the beginning or middle of your real estate career, this probably isn’t for you.

Should you be looking at an UPREIT?

So who is it for?

Before we answer that question, let’s be clear on one thing: You shouldn’t do anything based on one thought leadership article you saw on the internet. That advice goes well beyond investing for capital gains deferral. No matter your personal finance goals, the only firm advice we’re prepared to give you is to talk to someone who gives firm advice on personal finance goals for a living.

That said, the profile of an investor who should consider a 721 exchange is generally a seasoned real estate investor who is seeking to spend less time at work and more time at leisure. This person might also be of an age at which estate planning is becoming an increasingly important consideration – someone who wants to make life a little easier for the inheritors. The intention is that each heir should receive liquid assets rather than real property so they can each monetize their inheritance at their own convenience.

It practically goes without saying that this investor has a high net worth and is seeking a tax-efficient exit strategy for appreciated properties.

While 721 exchange volume and value comparisons are difficult to track over time – nobody has a duty to report them – a wide array of sources suggests that the pace is quickening rather than slowing. That’s impressive, especially considering the bang UPREITs started out with.

“A total of nine equity REITs had held initial public offerings (IPOs) in the United States in 1991 and 1992, the beginning stages of the Modern REIT Era. Yet, in 1993 alone, 44 equity REITs went public,” according to the industry group Nareit. “What changed in that one particular year? [OP units] and the expansion of the UPREIT structure came into vogue.”

The Nareit article goes on to say that the 721 exchange was invented in response to the extraordinarily tight lending restrictions that followed in the wake of the late 1980s’ savings-and-loan crisis.

“I was told by one banker that if you brought in cash as collateral equal to the amount you wanted to borrow, you still couldn’t get a loan … The scrutiny on real estate exposure was that strong,” one Taubman Centers executive told Nareit.

At the close

Still, that doesn’t explain the rapid drumbeat of new 721 exchanges today. We need to look at the broader economy to understand this better.

So perhaps the real reason why we’re seeing such a surge of interest in 721 exchanges today is that they’re necessary – not just for the affiliates, but for the general partnerships themselves.

Given current economic conditions, REITs may increasingly turn to private property owners as sources of capital, making UPREIT structures an attractive option for both investors and sponsors. They should not expect to do it out of a sense of public virtue. Rather, the firms that operate UPREITs – and DSTs for that matter – may benefit from seeing these private affiliates as dependable, flexible sources of the capital which they need to expand and modernize their portfolios.

And these affiliates, as wellsprings of resources needed to fuel the real estate market through what could be some narrow straits, may present strategic opportunities for both investors and REIT sponsors.

Sources:

https://www.govinfo.gov/content/pkg/USCODE-2011-title26/html/USCODE-2011-title26-subtitleA-chap1-subchapK-partII.htm

https://bin.ssec.wisc.edu/ABI/kaba/REIT/ch6.pdf

https://www.kiplinger.com/real-estate/deferring-taxes-with-a-721-exchange-pros-and-cons

https://media.velaw.com/wp-content/uploads/2019/11/28180433/c14d6fbb-276d-49e3-889b-16930b4e1945.pdf

https://www.govinfo.gov/content/pkg/COMPS-1885/pdf/COMPS-1885.pdf

https://www.naspp.com/blog/section-16(b)-the-short-swing-profit-rule

https://www.wallstreetoasis.com/resources/skills/finance/upreit-vs-downreit

https://www.irs.gov/faqs/interest-dividends-other-types-of-income/gifts-inheritances/gifts-inheritances

https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

https://www.reit.com/news/reit-magazine/november-december-2013/open-business

Investing in alternative investments may be speculative, illiquid, and not suitable for all clients. They are intended for investors who meet certain criteria and are willing and able to bear the unique economic risks of the investment. Investors should consider whether such investments are suitable in the light of their individual financial situation.

How to choose between public and private REITs: IN ONE PICTURE

Readers of this space have been asking us for some time, “Should I invest in public REITs or private REITs?” As with most investing questions, there’s no one-size-fits-all answer.

So, we did a little research and found that a lot has already been said about this question, and yet the question has never been answered. Not clearly, at least. So, without making you wade through the rest of the text, here’s one graphic that will help you make a clear, rational choice:

As you can see, it’s not a single decision. It’s a cascade of decisions. Now let’s walk through them one at a time.

Do you make enough money?

If you’re reading this, you probably make enough money to qualify as an accredited investor. That is, you make $200,000 or more if you’re single, or $300,000 as a married couple filing jointly. You need at least two years’ history in that range, and this gives you clearance from the Securities and Exchange Commission to buy into opportunities that are not appropriate for most retail investors.

Do you have enough money?

Even if you don’t currently have that kind of reportable income, if your personal net worth – excluding the value of your primary residence – exceeds $1 million, you’re probably still an accredited investor.

Regulation D of the Securities Act of 1933 offers other ways besides income or wealth for an individual to qualify for this distinction but, if you meet these requirements, you’re probably rich anyway. One other criterion involves being an insider of the project seeking the funds, so you’d likely already be personally invested.

Note that the Reg D requirements are joined together by the conjunction “or,” not “and”. As long as you clear any of these hurdles, you’re an accredited investor. And you must be an accredited investor in order to invest in private REITs.

And the buy-ins for private REITs can be high. The Corporate Finance Institute reports minimum investments of up to $100,000 for private issues.

Do you prefer regulated markets?

You can’t be an investor without having at least a little bit of a libertarian streak. But you can’t be prosperous enough to consider private REITs without at least a little bit of motivation to preserve your wealth.

The reason why the SEC requires you to demonstrate wealth or financial sophistication before investing in private REITs is the risk. We’ll talk specifically about liquidity risk next, but all manner of things can go wrong with a big-money bet on real estate. Exposure to economic downturns, realty market crashes are all part of the game.

So are exposures to specific geographies, tenants and properties, but there’s not much to be done about those. This, though, is the biggest substantive difference between public and private REITs. Public ones will tend to diversify portfolios across geographies to tamp down exposure to any one property. Private ones tend to laser-focus on a single development or management opportunity, according to Dividend.com. Because they zoom in like that, private REITs tend to have higher risks associated with such concentration. But with greater risks come, one hopes, greater rewards. As of 2024, public REITs average around 4% dividend yields, while private REITs’ yields can be roughly double that, though potentially with higher risk and less liquidity.

What makes public REITs safer than private ones is that regulators mitigate risks associated with the trades to get in and out of the vehicle, as well as those associated with dodgy management. Regulated markets provide assurance that the transactions proceed smoothly, the custodian is responsible and that the issuer’s financial statements reflect economic reality.

Private REITs wouldn’t be breaking any federal law if they never sent out an audited financial statement, so investors in these organizations take a lot on faith.

Do you need instant liquidity?

If liquidity is an issue for you, a public REIT might be the better choice. Of course, if you’re living paycheck to paycheck, liquidity is a central concern. Still, even wealthy people need cash flow.

Your home is probably your most valuable asset, unless your net worth is truly stratospheric – and even then. It might be a smaller proportion of your net worth, but it’ll still be sizable. But you can’t tip the pizza guy with a shingle. You need some liquid holdings.

And you get that from your investment in securities. That’s why you’re in blue chips, indexes, emerging markets, Treasuries, corporate bonds and munis. If you’re using securities for liquidity, REITs might be the last industry-specific holding to add – and public REITs offer far more flexibility.

If you do want to invest in real estate securities, though, and want to stick to the more liquid end, then public REITs are where you might want to start your search. That’s because they’re exchange-traded, same as stocks. Private REITs, on the other hand, trade among a rarified few market players. If you don’t know someone who wants to buy a position, you might encounter difficulty selling yours. Transaction costs, then, will tend to be higher for private REITs because someone has to act as intermediary.

Moment-to-moment or even month-to-month gyrations of the stock market have little effect on private REITS, a benefit that some say offsets the liquidity risk. This is especially true for long-term, buy-and-hold investors who don’t mind lock-up periods which range from three to 10 years.

Do you need more shielding from taxes?

All REITs have some tax advantages. Dividends may, by default, be taxed at the ordinary rate, but can often be interpreted as business income, which provides a lower effective rate. Since REITs must distribute a minimum 90% of earnings to shareholders each year, this income can be substantial.

When you sell your stake, of course, you would incur either a capital gain or a capital loss. Losses can reduce your taxable income this year, and carry over into future years. Long-term capital gains get taxed at a rate far below that of ordinary income and, as regular readers of this space know, those incurred from real estate transactions can be deferred for a generation.

Private REITs, though, provide even more tax shielding. Depreciation of a private REIT’s properties – assuming that it’s incorporated as an LLC, as is standard – can be passed through to shareholders. They in turn can deduct that depreciation from their adjusted gross income.

At the close

The public and private REIT markets are each trillion-dollar industries, so perhaps the liquidity risk of the private ones might be a little overblown. Still, there are good reasons why only accredited investors can participate.

Before you decide on which sort of REIT is right for you, take a moment and go through the flowchart above. Still unsure which type of REIT fits your goals? Reach out to one of our investment professionals — we’d be happy to walk you through your options.

Disclosures

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Real Estate Risk Disclosure:

There is no guarantee that any strategy will be successful or achieve investment objectives including, among other things, profits, distributions, tax benefits, exit strategy, etc.; Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments; Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities; Potential for foreclosure – All financed real estate investments have potential for foreclosure; Illiquidity – These assets are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions; Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits; Stated tax benefits – Any stated tax benefits are not guaranteed and are subject to changes in the tax code. Speak to your tax professional prior to investing.

Securities are offered through Realta Equities, Inc., Member FINRA/SIPC and investment advisory services are offered through Realta Investment Advisors, Inc., co-located at 1201 N. Orange Street, Suite 729, Wilmington, DE 19801.  Neither Realta Equities, Inc. nor Realta Investment Advisors, Inc. is affiliated with Perch Wealth.

Realta Wealth is the trade name for the Realta Wealth Companies. The Realta Wealth Companies are Realta Equities, Inc., Realta Investment Advisors, Inc., and Realta Insurance Services, which consist of several affiliated insurance agencies.

Why NOI isn’t the strongest metric for evaluating a REIT’s growth?

The majority of investors often look for investments that offer great benefits without much risk. Individual real estate investments do provide many benefits, but they also expose investors to great financial risks as well. However, a REIT or Real Estate Investment Trust allows investors to own large income-producing properties without the burden of owning or managing the properties. A Real Estate Investment Trust is a company that owns and in most cases, operates income-producing properties. Most REITs receive income in the form of rents by leasing spaces to tenants. A REIT can be divided into two categories –

How Equity and Mortgage REITs make money?

Let’s consider the equity REIT first. Suppose ‘APC’ is an equity  REIT. APC owns a couple of large income-producing properties and puts them on lease. Now, the rent received by APC from the rented properties is the company’s profit.

Say PAC is a mortgage REIT. Suppose, PAC raises $10 million from its investors and borrows another $40 million at 2% annual interest. Now, the company invests $50 million in mortgages that pay 5% interest. In this case, the company’s annual interest expense is $0.8 million or 2% of $40 million. Whereas, its annual interest income will be $2.5 million, which is 5% of $50 million.

Therefore,

PAC’s net income = (annual interest income – annual interest expense)
                             = $(2.5-0.8) million = $1.7 million       

How to evaluate a REIT’s growth?

Some investors often use net operating income as a metric to determine a REIT’s potential growth. However, since depreciation expenses are subtracted from net operating income, it isn’t a precise metric for evaluating a REIT’s growth. Qualified Investors use FFO (Funds From Operations) and AFFO (Adjusted Funds From Operations) for evaluating a REIT’s growth. FFO is calculated by adding depreciation expenses and subtracting any gain or loss from the sale of the property. Let’s consider an example.

Let’s assume a REIT’s net operating income in the year 2018 was $545,989 and the depreciation expense was $414,565. Whereas, the profit obtained from the sale of the property was $330,450.

FFO = (Net operating income + Depreciation expense –  profit on property sale)
        = $(545,989 + 414,565 – 330,450)
        = $630,104

Now, the company will use this residual income to fund dividend payments. As per the rules, a REIT must distribute 90% of its income among its shareholders as dividends.

Undoubtedly, FFO is more precise metric than net operating income for evaluating a REIT’s growth. However, it doesn’t include capital expenditure, which is also important. Once the tenure of a lease ends and a REIT leases out the property to a new tenant, they need to carry out improvement works in the property. This increases the capital expenditure and the REIT can use a portion of its income for carrying out improvement works. Therefore, qualified investors prefer AFFO over FFO for evaluating a REIT’s growth. Though there is no particular method for calculating AFFO, investors calculate it by subtracting the capital expenditure from FFO. Let’s assume the capital expenditure in this case to be $160,212.

Adjusted Funds From Operation = (Funds From Operation – Capital Expenditure)
                                                            = $(630,104 – 160,212)
                                                            = $469,892 As you can see, AFFO gives a more precise value, and that’s why it’s used by experts for calculating a REIT’s growth over the years.   

Innovative ways to plan a REIT Investment

A REIT generally has large investment properties in their portfolio. A REIT usually leases properties to tenants and earns income in the form of rent, which is then divided among its shareholders. In order to qualify as a REIT, a company must comply with the following rules –

How a REIT generates revenue?

Most REITs lease properties to tenants and make money from the rents, which is then divided among the shareholders as dividends. The majority of REITs trade on the National Stock Exchange and can be easily bought or sold. On the other hand, some REITs lend money to investors and earn interests on the loan. As you can see, a REIT’s source of income varies depending upon the sector in which that particular REIT operates.

Varieties of REITs

Profit  = (Annual interest income – annual interest expense)
             =$(3.5-1) million
            = $2.5 million.

The majority of REITs are equity REITs. However, trusts like mortgage REITs or publicly traded REITs also have their own benefits. Therefore, it’s important that you speak to an experienced REIT advisor, who can guide you through each of these REITs more deeply. We do have a team of highly qualified advisors for you. In no time, you could speak to up to three advisors.

Invest in REITs for long-term benefits

There won’t be any human on this planet who doesn’t want a secure and stable source of income in their life, particularly after retirement. That’s why people invest in mutual funds. The return may not be high, but there is an assurance. Same goes with REITs in real estate investment. REITs provide fixed returns (subject to market fluctuations) which increases along with the age of the investment. Though not every REIT functions in this way. There are different kinds of REITs available in the market, some of which trade on the National Stock Exchange.

Variation in REITs –

A Real Estate Investment Trust or REIT is a legal trust that owns, and in most cases, operates real estate properties. This kind of investment requires long term commitment and may not suit investors who like short-term benefits. The majority of REITs lease spaces to tenants and receive rents on those properties. On the other hand, some REITs fund loans to real estate developers.

Benefits of REIT Investment –

REIT investment is generally accompanied with many benefits, some of which are –

A Step By Step Guide for your REIT Investment

Published On - July 26, 2019

It’s an investor’s responsibility to keep searching for different investment options from time to time. Real estate investment requires a lot of patience and a positive attitude even in adverse situations. Buying a property only requires capital. However, maintaining the same property for a long time requires capital as well as a significant amount of time. That’s why some investors prefer mutual fund investment or Exchange-Traded Fund (ETF) over large individual real estate investments. An alternative to a mutual fund or ETF investment is Real Estate Investment Trust.

What is a REIT?

A Real Estate Investment Trust or REIT is a company or trust that owns, manages, and in most cases, operates income-producing real estate properties. REITs allow investors to own shares in real estate properties without the burden of purchasing and managing those properties. The majority of REITs lease spaces to tenants and earn rents on those properties. While some REITs also lend money to real estate developers and earn interest on the loan. This kind of investment requires a long-term commitment and it isn’t for investors seeking short-term benefits.

Who is it for?

Any investor can invest in REITs. Whether you’re a beginner or a pro, a REIT investment offers similar benefits to everyone. However, it may not suit every investor. An investment structure like REIT is more beneficial for retirees or someone who is on the verge of retirement than someone who is young and looking for short-term investments.  As REITs provide a steady flow of income for a long time, it suits people who have already hung their boots or are planning to do so.

What are the different types of REITs?

How to invest in a REIT?

You can invest in a REIT the way you invest in other company’s stocks or bonds. A REIT’s stocks can be easily purchased and sold on the National Stock Exchange. When you buy shares in a REIT, you invest in the trust and not in real estate properties. That’s why a REIT investment doesn’t qualify for a 1031 exchange. Real Estate advisors or experts can help in exploring the challenges that come with a REIT investment.

Should you use FFO or AFFO as a metric to measure a REIT’s cash flow?

Published On - July 26, 2019

Over the years, REIT investment has become a popular choice among real estate investors, particularly among the retirees. With benefits akin to that offered by a mutual fund investment, REIT lets investors invest in real estate properties without the burden of purchasing and managing those properties. The majority of REITs own, and in most cases operates, income-producing real estate properties. They lease spaces to tenants and then collect rents on those properties. Whereas, some REITs lend money to real estate investors and invest in mortgages and mortgage-backed securities.

Equity or Mortgage REIT – Which is better?

Equity REITs own and operate real estate properties. The primary source of income of an Equity  REIT is the rent they receive by leasing spaces to strong tenants. These kinds of  REITs provide high liquidity as their shares can be easily purchased and sold on the National Stock Exchange.

Mortgage REITs (mREITs) function in a different way. They lend money to real estate investors and invest in mortgage and mortgage-backed securities. The spread between the interest earned on the mortgages and the cost of financing the loan determines a Mortgage REIT’s income.

Since the Equity and Mortgage REITs have different working models, both are beneficial in different ways. Investors seeking instant income can go with Equity REITs. However, as they trade on the National Stock Exchange, they are subject to market risks. On the other hand, those who require funds for their real estate adventures may find Mortgage REITs a blessing in disguise.

How to evaluate a REIT’s cash flow?

Some real estate analysts use FFO (Funds From Operations) as a metric to measure the revenue generated by a REIT. There is a whole formula for calculating FFO. Analysts calculate FFO by adding depreciation and amortization in the net income minus any gain from the sale of real estate properties.

FFO = Net income + Depreciation + Amortization – Gain from the sale of real estate

FFO helps in calculating a more precise value as it adds depreciation in the net income and subtracts any gain the REIT has made from the sale of its real estate. Some analysts also use AFFO (Adjusted Fund From Operations),an advanced version of FFO, to get a more precise value. While there is no derived formula for calculating AFFO, it is taken out by subtracting recurring expenditures from FFO that are first capitalized by a REIT and then amortized. It could be some minor maintenance expenses such as money spent on changing floor carpet or repairing damaged ceiling, and so on.

AFFO =  FFO – Recurring Capital Expenditure

Both FFO and AFFO are used by analysts for calculating a REIT’s cash flow, and you too can use either of them. As REITs don’t need to make maintenance expenditures every day, you may ignore it. However, if you need a more precise value, consider subtracting it from a REIT’s FFO.

Real Estate Investment Trust – Who should invest?

Published On - August 2, 2019

A Real Estate Investment Trust is a company or trust that owns, and in most cases, operates real estate properties. REITs allow investors to invest in income-producing properties without the burden of going out and purchasing those properties. The business model of a REIT varies depending upon what kind of REIT it is. The majority of REITs make money by leasing spaces to tenants and then collect rents on those properties. A REIT’s benefits are akin to that of a mutual fund investment.

How a REIT is formed?

To form a REIT, a company must fulfill the following requirements –

Which REIT Investment is better?

There is no thumb rule for investing in REITs. Depending upon the objective behind the investment, an investor can invest in any of the following REITs –

The majority of REITs are listed with the Securities and Exchange Commission (SEC) and trade on the National Stock Exchange. However, some REITs that don’t trade on the National Stock Exchange or are not listed with the Securities and Exchange Commission. Private and Non-Publicly Traded REITs are a few to name.

REITs require a long-term commitment, investors eyeing short-term benefits should stay away –

What a REIT investment requires from you is a long-term commitment. Just like a mutual fund investment, a REIT investment gets better and better along with time. It may not suit investors who are looking for short-term investment options. A REIT’s large structure makes it suitable for small investors as the entry cost is usually on the lower side that may start from as low as $500 or the price of one share. Therefore, anybody looking for a secure and stable flow of income can invest in REITs.   

Do you need to be an accredited investor to invest in REITs?

What does being an accredited investor means?

There is no process of becoming an accredited investor. You don’t  need to apply for a license or pass a test to qualify as an accredited investor. Instead, your wealth or to be precise your annual income determines your accreditation. As per the Securities and Exchange Commission (SEC), to qualify as an accredited investor, an investor must have an individual income of more than $200k per year or a joint income of $300k. Many real estate investment structures accept only accredited investors and non-accredited investors can’t invest there.

What is Real Estate Investment Trust (REIT)?

A Real Estate Investment Trust or REIT is a private trust that owns, and in most cases, operates income-producing real estates. REITs have large institutional-grade properties in their portfolio. Some REITs invest in the commercial sector, while some are inclined towards the healthcare sector. The majority of REITs lease spaces to tenants and receive rents on those properties. Whereas, some REITs lend money to real estate investors and  earn interests on the mortgages and mortgage-backed securities. With benefits akin to that of mutual fund investment, REIT investment offers a steady flow of income for a long time.

Do I need to be an accredited investor for investing in REITs?

No, you don’t need to be one. Any investor can invest in REITs irrespective of how much wealth they possess. You can invest in a REIT just like you invest in the stocks of other companies. The majority of REITs are listed with the Securities and Exchange Commission and trade on the National Stock Exchange. Shares of a REIT can be easily bought and sold on the National Stock Exchange. As a REIT’s shareholder, you’ll be subject to receive dividends like other shareholders.

What are the different types of REITs?

There are three major kinds of REITs where you can invest –

How to plan a REIT investment?

Though you can invest in a REIT with the help of a broker, you may want to consult your financial advisor or a REIT expert before that. As shares of a REIT can be bought and sold on the National Stock Exchange, a REIT investment is subject to market risks.

Everything You Should Know About Real Estate Investment Trust

Published On - August 12, 2019

Though real estate investments offer great benefits, they don’t guarantee fixed returns. Holding an investment for a long time may result in rising maintenance expenditure on the property, which increases an investor’s liabilities. To give investors a flexible and more secure investment structure, REIT investment was introduced in the United States.

What is a REIT?

A Real Estate Investment Trust or REIT is a company that owns, and in most cases, operates income-producing properties. Akin to mutual fund investment, REITs allow investors to invest in a more flexible and secure investment structure. The majority of REITs lease spaces to tenants and receive rents on those properties. That’s their main source of income.  On the other hand, some REITs lend money to real estate investors and invest in mortgage and mortgage-backed securities.

How a REIT is formed?

A company must fulfill the following requirements to form a REIT –

Benefits of REIT Investment –

Types of REIT –

What’s the right time to invest in REITs?

There is no so-called right time to invest in REITs. REIT investment can be planned anytime in a calendar as it provides the same benefits irrespective of the time when the investment is made. However, you may want to consult your financial advisor or a REIT expert before investing in REITs.