Frequently Asked Questions
Q: What is a real estate investment trust (“REIT”)?
A: A REIT is a company that raises money through its stockholders in an effort to acquire, and in many cases operate, income producing commercial real estate. Some REITs also engage in financing real estate. In order for a company to qualify as a REIT, it must comply with certain strict provisions within the Internal Revenue Code. For example, at least 75 percent of the company’s total assets must be invested in real estate, at least 75 percent of its gross income must come from rents from real property or interest from mortgages, and REITs are required to pass at least 90 percent of taxable income to stockholders.
Q: Why were REITs created?
A: REITs were created by Congress in 1960, in part to make investments in large scale, income-producing real estate assets more accessible to smaller investors. Congress determined that a way for individual investors to invest in large scale commercial properties was the same way they invest in other industries, through the “pooling” of capital to purchase equity. In the same way as shareholders can benefit by owning stocks of other corporations, the stockholders of a REIT earn a pro-rata share of the economic benefits that are derived from the production of income and potential appreciation of commercial real estate ownership.
Q: What types of REITs exist?
A: There are two primary types of REITs. They are as follows:
1. Publicly-Traded REITs– “Traded REITs” or “listed REITs” are registered with the U.S. Securities and Exchange Commission (the “SEC”) and shares are bought and sold on a national stock exchange just like traditional exchange-traded stocks or funds. While they can provide many of the benefits associated with direct real estate investing, such as income producing dividends, these Traded REITs are subject to the same market volatility and fluctuations of any stock or fund that is traded on a national stock exchange. As a result, investors who invest in Traded REITs should anticipate some correlation to the stock market and the potential for more volatility due to fluctuations in the stock market.
2. Unlisted REITs – “Non-Traded REITs” or “unlisted REITs” are also registered with the SEC, however, shares of these REITs are not publicly traded on any national stock exchange and are, thus, less correlated to the stock market*. The real estate behaves more like a hard asset. As a result, investors’ returns are based more upon the performance of the real estate owned by the REIT and have less outside influence from the stock market. Unlisted REITs, however, do not offer the liquidity of a publicly-traded REIT. Due to the lack of liquidity of unlisted REITs, there are certain income and net worth requirements that must be met in order to qualify for this type of investment.
Q: What types of properties do REITs purchase?
A: REITs invest in a variety of property types and each REIT will take a different strategy in the types of properties they acquire and the objectives of those properties. Property types include office buildings, shopping centers, healthcare facilities, apartments, hotels, warehouses, self-storage facilities and more. Most REITs specialize in one property type. For example, a multi-family apartment REIT will look to acquire and manage only apartment or apartment types of assets and a healthcare REIT will specialize in acquiring and managing health care facilities. On the other hand, there are some REITs that are more “hybrid” in that they don’t seek one particular type of property. Instead, they look to acquire multiple property types in an effort to achieve a certain objective. REITs will also differ with respect to acquisition objectives. For example, while one REIT might look for more stable properties that have existing tenants in place, with long term leases and located in stable real estate markets, another REIT might look to acquire properties that are struggling so that they can bring value to that property and ultimately a higher rate of return. Any of these REITs might look to specialize in one geographic region, whereas another REIT might invest nationally or even globally. Each objective brings its own level of risk and potential reward and it is important that investors match their objectives to those of the REIT, and are comfortable with the risks that they are incurring in purchasing shares of the REIT.
Q: What are general benefits of REITs?
A: REITs offer the distinct advantage of greater diversification through investing in a portfolio of properties rather than a single property. They also provide management by experienced real estate professionals. REITs are designed to provide investors with steady income in the form of monthly or quarterly dividends, as well as growth potential in the appreciation of the properties owned by the REIT.
REITs may also help investors diversify their assets and overall portfolio allocation. While most investors have substantial holdings of stocks, bonds and mutual funds, for many investors, real estate is overlooked. Many investors feel that in order to invest in real estate, they must have substantial amounts of capital, assume new debt and loans and be experienced at managing real estate. REITs can help alleviate some of these requirements as they offer low minimum investments, they do not require investors to acquire a loan and the properties are managed by experienced real estate professionals. Although diversification does not guarantee against losses, an unlisted REIT can help diversify a portfolio that is heavily concentrated in stocks or other traded securities, by spreading out the risk and allowing investors to incorporate real estate into their portfolio. Tax advantages are often passed along to investors in REITs, which are not taxed at the corporate level. Some stockholders can also reduce their overall tax burden with the property depreciation benefits that REITs may create. Investors are always encouraged to seek a tax professional in determining the tax benefits of a REIT as it relates to their personal tax planning**.
Q: What are general risks of REITs?
A: As with any investment, REITs are not immune to risk. Some of these risks include, but are not limited to the following: (1) There is no guarantee regarding future performance and upon the sale or distribution of the REIT’s assets, stockholders may receive less than their initial investment; (2) real estate values can increase or decrease based upon economic factors, including interest rates, laws, operating expenses, insurance costs, unemployment, tenant turnover, and other considerations; (3) publicly-traded REITs, which are traded on national stock exchanges, are subject to stock market volatility; (4) Unlisted REITs, which are not traded on any national exchanges, do not have a public market and, as a result, may lack liquidity and transferability; (5) Distributions from REITs may be paid from offering proceeds, the sale of assets or borrowed funds; and (6) There are fees associated with investments in a REIT and those fees may affect the overall performance of the investment.
Q: Which REIT is right for me?
A: Hundreds of REITs exist in today’s marketplace, and it is important that investors perform adequate due diligence as they select the REIT(s) that best meet their investment objectives. It is important that investors understand the differences between a publicly traded REIT and an unlisted REIT. Investors should consult a financial professional with expertise in commercial real estate as many financial professionals are not adequately trained to understand the intricacies associated with these types of investments. Before investing in a REIT, investors should review a prospectus and understand the objectives, risks and fees associated with each investment.
Q: What is the typical “lifecycle” of unlisted REITs?
A: An unlisted REIT will generally go through multiple phases during its lifecycle and ultimate completion. These phases generally include the following:
*Source: J.P. Morgan Asset Management, “Guide to the Markets Q3 2009”, As of June 30, 2009
**CTT does not provide tax advice. Potential purchasers of REIT shares should first consult with their attorney, accountant, or another qualified tax professional.