A Real Estate Investment Trust (REIT) is a company that owns and operates income-producing real estate or real estate-related assets. In 1960, the U.S. Congress established REITs so individuals could invest in large-scale, income-producing real estate. Through REITs, individual investors can own a piece of commercial properties that would ordinarily be out of their price range.
The assets owned by a REIT may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans, according to an investor bulletin issued by the Securities and Exchange Commission (SEC) in 2011.
Most REITs specialize in a single type of real estate such as apartment complexes. REITs may also concentrate in office properties, or healthcare or industrial properties, among other possibilities. REITs are different from other real estate companies in that they must develop the real estate properties and operate them as part of their own investment portfolio, as opposed to reselling the properties after development, the SEC bulletin says.
A company must have most of its assets and income connected to real estate to qualify as a REIT. In addition, each year a REIT must distribute at least 90 percent of its taxable income to shareholders as dividends. REITs are allowed to deduct these dividends and because of this, most REITs pay out all their taxable income to shareholders and do not pay corporate tax, the SEC bulletin says.
Other REIT qualifications:
Three Types of REITs
As a rule, there are three categories of REITs, according to the SEC bulletin: equity, mortgage, and hybrid. Equity REITs that own and operate income-producing real estate are the most common.
Mortgage REITs lend money to real estate owners and operators directly as mortgages or other loans, or indirectly through the acquisition of mortgage-backed securities. These REITs usually borrow more of the capital they need than does an equity REIT. Mortgage REITs may also manage interest rates and credit risks through the use of derivatives and other hedging strategies. The SEC bulletin states that investors need to understand the risks attached to these strategies before buying in.
Mortgage REITs may be similar to real estate investment companies in that they often invest in debt secured by commercial and residential mortgages. As it stands, companies with a majority of their assets in real estate are exempt from the rules that govern other investment vehicles, such as mutual funds. According to the SEC bulletin, this policy is under review to determine whether it should continue considering the collapse of the mortgage-backed securities market in 2008 and the resulting financial crisis. If the same rules are applied to REITs, they would limit how much a REIT could be leveraged-up as well as regulate fees.
The third category – the hybrid REIT -- uses the investment strategies of both equity REITs and mortgage REITs, as the name suggests.
Trading Categories of REITs
REITs also differ as to trading status. Publicly traded REITs are registered with the SEC and trade on a stock exchange. Non-traded REITs are registered with the SEC, but do not trade publicly. They are also known as non-exchange traded REITs.
Characteristics of Publicly Traded REITS:
Characteristics of Non-Traded REITs:
SEC Warnings Regarding Non-Traded REITs
Non-traded REITs are illiquid investments, the SEC bulletin says. They cannot be sold on the open market as a rule, so investors cannot use these shares to raise capital quickly. Though they may feature share redemption programs, these programs usually have substantial limitations and the company may discontinue them at its discretion.
The timing of liquidity events such as the listing of the REIT on an exchange or the liquidation of assets is also at the company's discretion, and might happen 10 years or more after the investment is made.
In addition, the SEC states lists transparency as a concern. The true value of shares of a non-traded REIT can be hard to ascertain. No market price is available because they are not traded on an exchange, and they usually don't provide any estimate of value until about a year-and-half after the offering has closed, which could in fact be years after a people have made their investments. Therefore, investors may be unable get a read on the value of their non-traded REIT investments for a long time and may not be able to determine volatility.
Cost is another area of concern. Non-traded REITs are usually sold by financial advisers who may charge high fees upfront that can substantially lower the value of the investment. Upfront sales commissions and offering fees can run from 9 percent to 10 percent and investors need to understand that the amount invested in the REIT is reduced by these commissions.
Investors should also be aware that the distributions of a non-traded REIT may be paid from capital raised through offerings and with borrowed money. While investors may be drawn to these REITS by their seemingly high dividend yields, they need to consider the total return.
Unlike publicly traded REITs, non-traded REITs often pay distributions that exceed what they take in from operations. This cuts into share value and reduces the amount of cash the REIT has available to purchase more income-producing assets. Investors should assess what portion of the distributions of a non-traded REIT have been paid using sources other than operating revenue.
Conflicts of interest may also be a problem, according to the SEC bulletin. Non-traded REITs are generally managed by a third party. This external manager may take in substantial fees for things that are not aligned with shareholders' interests. For example, if the manager receives fees based on the amount of property acquired and assets under management, the manager may make purchases that only make sense in terms of the fees they generate. Moreover, the third-party manager might manage competing REITS.
Homework is a Must
Would-be investors need to assess their own finances, consult a financial adviser and perform their own in-depth research before buying into a REIT. Potential investors can review the annual and quarterly reports a REIT has filed with the SEC, as well as any offering prospectus, at sec.gov.
Shares in publicly traded REITs, which are listed on major stock exchanges, are normally purchased through a broker like other publicly traded securities. As is typically of many public companies, you can purchase common or preferred stock or debt securities.
Non-traded REIT shares may be purchased through a broker who has been engaged to participate in the offering. Other investment options include REIT mutual funds or exchange-traded funds.
Since the real-estate market collapse and credit crisis of 2008, investors have been bringing numerous claims against brokerage firms, brokers or advisors who recommended REITS that were either unsuitable or simply fraudulent. Other claims have involved the failure to disclose the high fees and commissions often associated with REITs.
If you have been the victim of securities fraud you should consult with an attorney. The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Firm, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.