Understanding REITs & How They Work
REITs, or real estate investment trusts, are companies that combine the capital of many investors to acquire or invest in income-producing commercial real estate and related assets. These real estate companies must meet a number of requirements to qualify as a REIT.
REIT stockholders typically earn a share of the income produced by the portfolio of properties through distributions or dividends. An important feature of REITs is that they must pay at least 90 percent of their REIT taxable income to stockholders in the form of distributions on an annual basis, potentially providing a consistent stream of income to investors.
Types of REITs
There are two types of REITs: publicly traded REITs and non-listed REITs.
Publicly traded REITs are liquid investments that can be bought and sold on a public exchange and are subject to share price fluctuation that may be unrelated to the underlying real estate assets.
Non-listed REITs are illiquid investments by design and experience value fluctuations related to the underlying real estate assets.
NAV, or net asset value, non-listed REITs are attractive to many investors today because they can offer more frequent repurchase or redemption options based the current per share NAV.
Potential investors can buy shares of a publicly traded REIT on an exchange, while non-listed REIT shares are typically sold through investment advisors or financial planners.
How Does a REIT Work?
Most REITs that invest in income-producing properties, or equity REITs, have a straightforward business model: the REIT leases a property to tenants that pay rent, which is then passed to investors via distributions, a majority of which is considered tax-advantaged income.
Benefits of a REIT Portfolio Allocation
There are approximately 150 million Americans invested in REITs through 401(k)s, IRAS, pension plans, and other investment funds.
Inflation Hedge: Acquiring income-producing properties with built-in rent increases or the potential to increase rents gives stockholders a unique opportunity to keep up with inflation as well as participate in capital appreciation.
Tax Advantage: Possible elimination of “double taxation” (taxation at both the corporate and stockholder) if the REIT distributes at least 90 percent of taxable income to its stockholders each year.
Diversification: REIT can be diversified by property type, location, tenant and/or lease term which can help smooth portfolio risk.
Passive Investing: REIT investors own interests in income-producing properties but there are no management responsibilities to worry about.
Transparency: Traded and public non-listed REITs are required to file financial reports with the United States Securities and Exchange Commission (SEC).
Low Correlation: Non-listed REITs have low correlation to traded securities.
The Power of Owning Non-Correlated Investments
Including assets that have a low correlation to each other helps to reduce the amount of overall risk for a portfolio. Non-correlated investments include those that aren’t correlated with stocks, meaning the value does not follow the same ups and downs as the stock market. By combining assets that exhibit low correlation, investors can work to reduce portfolio risk without sacrificing return potential. Low or negative correlation means that investments behave differently from each other through changing market environments.
This article was originally published by Inland Securities.