Updated on October 26, 2021
The Basics and Requirements of Real Estate Investment Trusts
What are Real Estate Investment Trusts? What are the basics and requirements for a Real Estate Investment Trust? In this blog, we discuss some REIT basics and identify three main REIT requirements.
There are many ways that a person or institution can invest in real estate. Common examples include house flipping, buying residential rental properties, or buying commercial real estate and renting it out to tenants. However, a less well known but frequently utilized investment strategy is investing a Real Estate Investment Trust, or “REIT”.
Real Estate Investment Trusts are modeled after mutual funds and allow investors to pool their money into a number of real estate-related investments. Specifically, when purchasing shares in a Real Estate Investment Trust, an investor buys shares in an entire real estate portfolio. Often times, REITs are specific to a sector. For example, a REIT may include a number of properties in the healthcare sector, or in the energy sector. A REIT is led by a board of directors or a trustee, who generally lease the REIT’s portfolio of properties out to tenants, collect the income, and disburse it to the shareholders in the form of dividends. This is the most common type of REIT and is called an “Equity REIT”. However, some REITS are called “Mortgage REITs”, which finance real estate instead of owning real estate. Investors in Mortgage REITs are paid out through the interest earned on the loans.
REITs first originated in the 1960s. Today, Real Estate Investment Trusts are governed by a complex series of laws including those in the Internal Revenue Code. Many of these laws fall into three broad categories:
The Asset Requirement:
This assures that the vast majority of the REIT’s assets are specific to the real estate sector. Specifically, 75% of the total value of the assets owned by the REIT must include real estate holdings, cash or US treasury bonds. To that end, no more than 25% of the value of the REIT may consist of other assets or securities.
The Income Requirement:
A REIT must generate 75% of its gross income from real estate-related sources. Examples include rents from real property, interest obligations secured by mortgages, income attributable to investments in other REITs, refunds of real property taxes, and income generated from foreclosure properties.
The Distribution Requirement:
A REIT must distribute 90% of the taxable income it generates each year in the form of dividends to the shareholders.
Indeed, these requirements are in place for a number of reasons. For example, the requirements assure that the REIT’s portfolio is substantially comprised of real estate-related assets. Additionally, these requirements establish thresholds for REITs to help potential investors identify fraudulent REITs before they invest. To that end, it is important for investors in REITs to carefully vet a REIT before investing.
Legal issues involving REITs are often complex. If you have an issue involving a REIT, including but not limited to an issue involving fraud, you may want to consult with an attorney. The attorneys at Schorr Law have years of experience assisting clients with real estate needs, including real estate investments gone bad. Contact Schorr Law to schedule a consultation, today.