What Is a Real Estate Investment Trust (REIT)?

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate. Modeled after mutual funds, REITs pool the capital of numerous investors. This makes it possible for individual investors to earn dividends from real estate investments—without having to buy, manage, or finance any properties themselves.

How REITs Work

Congress established REITs in 1960 as an amendment to the Cigar Excise Tax Extension. The provision allows investors to buy shares in commercial real estate portfolios—something that was previously available only to wealthy individuals and through large financial intermediaries.1

Properties in a REIT portfolio may include apartment complexes, data centers, healthcare facilities, hotels, infrastructure—in the form of fiber cables, cell towers, and energy pipelines—office buildings, retail centers, self-storage, timberland, and warehouses.

In general, REITs specialize in a specific real estate sector. However, diversified and specialty REITs may hold different types of properties in their portfolios, such as a REIT that consists of both office and retail properties.

Many REITs are publicly traded on major securities exchanges, and investors can buy and sell them like stocks throughout the trading session.2 These REITs typically trade under substantial volume and are considered very liquid instruments.

What Qualifies as a REIT?

Most REITs have a straightforward business model: The REIT leases space and collects rents on the properties, then distributes that income as dividends to shareholders. Mortgage REITs don't own real estate, but finance real estate, instead. These REITs earn income from the interest on their investments.

To qualify as a REIT, a company must comply with certain provisions in the Internal Revenue Code (IRC). These requirements include to primarily own income-generating real estate for the long term and distribute income to shareholders. Specifically, a company must meet the following requirements to qualify as a REIT:

• Invest at least 75% of total assets in real estate, cash, or U.S. Treasuries

• Derive at least 75% of gross income from rents, interest on mortgages that finance real property, or real estate sales

• Pay a minimum of 90% of taxable income in the form of shareholder dividends each year

• Be an entity that's taxable as a corporation

• Be managed by a board of directors or trustees

• Have at least 100 shareholders after its first year of existence

• Have no more than 50% of its shares held by five or fewer individuals

Types of REITs

There are three types of REITs:

• Equity REITs. Most REITs are equity REITs, which own and manage income-producing real estate. Revenues are generated primarily through rents (not by reselling properties).

• Mortgage REITs. Mortgage REITs lend money to real estate owners and operators either directly through mortgages and loans, or indirectly through the acquisition of mortgage-backed securities. Their earnings are generated primarily by the net interest margin—the spread between the interest they earn on mortgage loans and the cost of funding these loans. This model makes them potentially sensitive to interest rate increases.

• Hybrid REITs. These REITs use the investment strategies of both equity and mortgage REITs.

Source: https://www.investopedia.com/terms/r/reit.asp