How Do Real Estate Investment Trusts Work?
Real estate investment trusts or REITs are corporations that acquire and manage real estate properties, typically commercial ones, and mortgages. In a publicly-traded organization, you can buy shares and earn income through dividends.
In essence, REITs allow you to invest and own commercial spaces, which are usually more expensive than other assets, by pooling the funds of those who buy shares or stocks from them. You get to enjoy the benefits of real estate ownership without the headache that entails tenant management, rent collection, and facilities maintenance since the group hires a professional property manager.
How REITs Differ from Traditional Real Estate Investing
There are two primary traditional real estate investing strategies. One is called the “fix-and-flip,” where investors earn money by buying distressed properties and renovating or remodeling them, then selling them for a profit. The second strategy is more long-term and involves developing a space or acquiring it then leasing it out to tenants.
According to REITs.org, this investment setup is an alternative to the second strategy since, as mentioned above, you revel in the perks of being a landlord without having to go through the tedious tasks that accompany the role.
The Standard REIT Structure
Generally, REITs involve these three factors:
IPO - The organization holds an initial public offering or IPO to raise funds from unit holders or investors. The money is used by the REIT to buy several commercial real estate properties.
Lease - These properties are then rented out to tenants.
Dividends - The income gained from rent collection is returned to the investors in the form of dividends, also known as profit distributions. The dispersal of the funds typically happen quarterly, and you get full control on whether you want to reinvest it or use the money elsewhere.
Key Facts You Should Know
This alternative setup to traditional real estate investing seems to offer a massive win to investors. If you’re planning to try your hand at this venture, here are a couple of things you should know about:
1. There are Two Primary Types of REITs
With so many REIT companies out there, it’s crucial that you know which type works best for your intended investment portfolio. There are two primary types of REITs: equity and mortgage.
Here’s a brief look at each type:
Equity - Most REITs are involved with equity where the corporation owns and manages income-generating real estate investments. This setup is the one typically referred to by the market when it uses the term REITs.
Mortgage - Mortgage or mREITs are organizations that buy or originate loans and mortgage-backed securities. These groups earn income from their investments’ interests.
Meanwhile, some REIT sub-sectors include:
Retail - Lots of REITs have built or acquired malls, shopping centers, and outlets.
Healthcare - Properties in this sub-sector comprise of hospitals, senior housing facilities, and clinics.
Industrial - Industrial REIT properties can be warehouses and factories.
Travel - You can also find REITs that own hotels, destination resorts, and motels.
Storage - Some corporations own public self-storage facilities while others own buildings that rent out space specifically for servers used in data storage.
2. REITs Legally Avoid Corporate Tax
REITs are bound by law to distribute a massive chunk—at least 90 percent—of their taxable income to unit holders annually. This legal obligation allows them to avoid paying for corporate taxes, which usually taxes the same money twice.
When a big corporation earns an income, it’s taxed at the corporate level. However, a portion of the dividends it distributes to shareholders is also taxed at the personal level.
REITs avoid this double taxation scenario since the dividends from this setup are deemed as ordinary income by the unit holders. Because they end up with more profits, they are able to return above-average dividends.
3. Be Aware of the Risks
While REITs may seem to be perfect investments, it’s crucial to understand that there are still risks involved. You need to study industry trends to figure out the type of REIT that’s more beneficial for your portfolio.
For instance, the advent of online shopping has led to a decline in mall traffic. So, it wouldn’t be practical to put money in REITs that focus on retail properties.
Conclusion
REITs have a relatively simple structure. They gather funds from interested investors and use the money to purchase commercial real estate spaces as well as hire a property manager to oversee tenant relationship and rent collection. Then, the income generated from these properties is distributed back to the unit holders.
You can choose to invest in equity or mortgage REITs, depending on which one you feel is best for your investment portfolio. These organizations have owned various properties in different sub-sectors like retail, healthcare, and travel. Before you start investing in REITs, you should study industry trends so you can put your money in the most profitable assets.
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