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 –
- The company must invest 75% of its assets in real estate, cash or treasuries.
- It must receive 75% of its income from property rents, sale of its real estate or from the interest on the mortgages.
- The company must distribute 90% of its income among its shareholders. The remaining 10% can be reinvested in new properties or assets.
- A REIT must have at least 100 shareholders after one year of its existence.
- Not more than 50% of the shares are owned by its five or fewer shareholders during the last half of the taxable year.
- The company must be taxable as a corporation.
- The company must be managed by a board of directors or trustees.
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
- Equity REIT – Equity REITs buy, own and sell investment properties. These REITs generate revenue through rents and not by selling real estate properties. They are publicly traded on the stock exchange.
- Mortgage REIT – As the name suggests, Mortgage REITs lend money to investors and earn interests on the loan. They also borrow money at low-interest rates and then buy mortgages that could pay a higher return. The spread between the two interest rates is the REIT’s profit. For example, let’s say a REIT raises $20 million through its investors. It borrows another $50 million at an interest of 2% per annum or $1 million, which is the annual interest expense of borrowing. Now, it uses this $70 million for buying mortgages that pay 5% interest or $3.5 million, which is the annual interest income generated from the mortgage. The spread between these two interest rates will be the REIT’s profit, which in this case is –
Profit = (Annual interest income – annual interest expense)
= $2.5 million.
- Hybrid REIT – Hybrid REITs are the ones that own and lease investment properties as well as fund mortgage loans to real estate investors. Basically, it’s a mixture of Equity and Mortgage REITs.
- Publicly Traded REITs – These REITs are listed with the Securities and Exchange Commission (SEC), and trade on the National Stock Exchange. The shares of these REITs can be easily bought and sold. These REITs are regulated by the U.S. Securities and Exchange Commission.
- Publicly Non-Traded REITs – These REITs are also registered with Securities and Exchange Commission but don’t trade on the National Stock Exchange. They are more illiquid than publicly traded REITs but could be more stable, as they are not subject to market fluctuations.
- Private REITs – These REITs are neither listed with the Securities and Exchange Commission nor do they trade on the National Stock Exchange. They are accessible to only a few selected investors.
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.