A Real Estate Investment Trust is similar in function to a mutual fund. It takes money from investors and invests it. In this case, a REIT allows the public to invest in large, income-producing commercial real estate (CRE) without buying the property.
Say you want to invest in commercial property but don’t have enough capital to buy the company. You can go to your nearest stockbroker and buy REIT shares, earning dividends as the REIT profits from its properties.
How Does a REIT Work?
A REIT is started when initial investors come together to create a company, let’s name it Company X. These group of initial investors hires finance professionals to manage the company and invest its capital. Company X then buys a series of commercial real estate properties, say a mall. This mall generates income, and the income goes through the REIT and divided among its investors according to how many shares of Company X they own.
In order for the Securities and Exchanges Commission (SEC) to recognize a company as a REIT, it must fulfill the following conditions:
– Hold at least 75% of its assets as real-estate assets.
– 75% of its income must come from real-estate asset revenue.
– Payout 90% percent of its taxable income to its investors and stakeholders.
– Must be classified as a corporation.
– The company must be managed by a board of directors or board of trustees.
– The company must have at the very least 100 share-holders.
– Not more than 50% of its shares is held by five share-holders or fewer.
Once the company has fulfilled these requirements, it can now be officially called and classifieds a real-estate investment trust.
Advantages of Investing in a REIT
Higher Dividends – Because the Securities and Exchanges Commission (SEC) requires REITs to payout 90% of its taxable income to its investors, REITS usually have higher dividends than other stocks.
Secure Source of Income – Since REITs invest in commercial real estate, long term leases of those CREs will mean a steady flow of income for its investors.
High Liquidity – REIT shares are traded publicly, making it easy for an investor to buy and sell. If you invest in real estate in the traditional route, there is a long process you have to go through before you can sell your property.
Professional Management – Since a REIT is managed by a professional team of finance experts, an investor doesn’t have to do any work. There are no landlord responsibilities. If you invest in a REIT, passive income will come your way.
Disadvantages of Investing in a REIT
Lack of Diversification – The SEC requires that REITs invest 75% of its assets on real estate. As a result, the success of REIT companies is heavily reliant on the state of the real estate market.
Slow Growth – Since the SEC requires that 90% of the REIT’s taxable income be paid out to its investors, only 10% is retained within the company. This makes rapid growth hard to achieve.