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 A real estate investment trust or REIT is a company or entity that invests in different kinds of real estate including shopping malls, commercial office buildings, and hotels. This kind of trust can also invest in real estate related assets such as mortgages.
According to the Security and Exchange Commission, there are basically three types or definitions of REITs:
- Equity REITs - this is the most common type of real estate investment trust, whereby the owners or managers of the trust invest in, or take possession of, real estate assets and make money by charging rents.
- Mortgage REITs - mortgage REITs are entities that lend money to real estate developers or invest in financial instruments such as those issued by Fannie Mae, which are secured by mortgages.
- Hybrid REITs - a hybrid REIT is essentially an entity that invests both like an equity and mortgage REITs.
Qualifying as a REIT
For a company to qualify as a real estate investment trust, according to standards established by the SEC, the company must pay 90% of its taxable income to its shareholders each year. The company must also invest at least 75% of its total monies in real estate and at least 75% of its gross income must come from investments in property or mortgages.
You can invest in REITs through stock exchanges and those companies that are publicly traded must file reports with the SEC.
Benefits of Real Estate Investment Trusts
Historically, the wealth of an individual was measured in terms of the amount of land a person owned. Today, wealthy individuals can take partial ownership in companies by investing in stocks and bonds. But the door has also been opened for the average investor to participate in the real estate market through REITs.
In fact, when Congress passed the Real Estate Investment Trust Act of 1960 it allowed companies to be exempt from corporate income tax if the criteria mentioned above were met. Congress hoped this financial incentive would result in an increase in the number of investors pooling their money together to form real estate trusts.
Management of Properties
Although the primary benefit of REITs is that they allow the average investor to participate in the real estate market, there are other significant benefits from this arrangement such as the professional management of the properties. If an individual were to purchase a property on their own, then they would be responsible for managing the property. With a REIT, the properties are managed by industry professionals.
Controlling Risk
Another benefit of an REIT to an investor is the ability to control or limit their risk. If an investor were to begin investing in real estate by purchasing just one property, it is likely they would have to take a personal loan out to finance the purchase. In this situation, the success or failure of this one project exposes the investor to a great deal of personal risk.
By investing in a REIT, the individual is purchasing a share of the trust. This means the risk of failure or success is no longer limited to just one property. The trust would own a diverse portfolio of real estate properties and the investor automatically benefits from this diversification.
Real Estate Bubbles and REITs
We've discussed the benefits of REITs to the investor, so now let's switch gears and talk about the risks of REITs. That being said, no discussion of real estate trusts would be complete without addressing concerns over the real estate bubble.
In many areas of the country, there has been a sharp rise in the cost of buying a home. Many individual investors also own homes, so they are acutely aware of this rise in housing prices and the talk of a real estate bubble that may burst at any moment. For this very reason these same individuals shy away from REITs.
What these investors don't realize is that a rise in residential real estate values does not affect all REITs. Commercial and residential real estate are very different markets. Just because the values of homes are on the rise has nothing to do with the popularity of businesses such as Public Storage or other REITs that invest in commercial properties.
So while the real estate bubble may be of some concern to REITs heavily invested in residential real estate developers, it has very little to do with the performance of trusts investing in commercial real estate.
REITs and Retirement
Only recently, the New York Times reported that 401k plan sponsors are looking to offer participants alternatives to stocks and bonds in recent years. Many of these 401k plans are now turning to real estate mutual funds that hold REITs. If your plan administrator does their homework, there is no reason they cannot find suitable funds to offer participants.
This last statement is true because under the surface, a well run REIT is not any different than any other well run business in a totally different industry. If the company puts together a portfolio of products or services that makes sense to investors and treats its shareholders fairly, then it is likely to prosper regardless of whether or not it is a real estate investment trust or General Electric.
International Real Estate Investment Trusts
The popularity of REITs in the United States has lead to the spread or promise of REITs appearing internationally. The three most promising markets include Japan, the United Kingdom, and Germany.
Japanese REITs
Japan is perhaps the most interesting of the Asian nations to pass REIT legislation back in December 2001. Japanese REITs, also referred to as J-REIT are traded on the Tokyo Stock Exchange. REIT organizers and participants include foreign investment banks, and conglomerates operating out of Japan.
Since experiencing a drop in property prices in the 1990s, Japan finally appears to be seeing prices starting to increase. If this becomes a trend, the interest in J-REITs will rise sharply.
United Kingdom REITs
More recently the rules for establishing a United Kingdom REITs have been established and this legislation is thought to be enacted as part of the Finance Act 2006 - which went into effect in January 2007.
Like US REITS, these newly formed UK REITS will have to distribute a large share (95%) of its income back to shareholders. Other rules include making the UK REIT a closed end trust, the fund must be physically based in the UK and listed on a recognized stock exchange.
Supporters of these real estate investment trusts in the UK have even created an organization known as The REITs and Quoted Property Group. Organizers include leading commercial real estate companies, the British Property Federation as well as the London Stock Exchange.
German REITs
Finally, Germany is also planning to introduce real estate investment trusts in the not too distant future. The rationale for allowing REITs in Germany stem from a fear of investment loss to competing countries. The hope is that a G-REIT will keep investors interested in the German real estate market.
Exact details of the G-REIT have still not been finalized but the Ministry of Finance plans to introduce G-REITs as early as 2007. It appears most of the rules and regulations are adaptations from the UK model.
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