A real estate investment trust, or REIT, is a company that owns, operates or finances income-producing real estate. For a company to qualify as a REIT, it must meet certain regulatory guidelines. REITs often trades on major exchanges like other securities and provide investors with a liquid stake in real estate.
REITs are not a new financial innovation. Established by Congress in 1960 as an amendment to the Cigar Excise Tax Extension of 1960, REITs operate in a manner comparable to mutual funds as they allow for individual investors to acquire ownership in commercial real estate portfolios that receive income from properties such as apartment complexes, hotels, hospitals, office buildings, timber land, warehouses, hotels and shopping malls.
A company must meet the following requirements to be qualified as a REIT:
- Invest at least 75% of its total assets in real estate, cash or U.S. Treasuries
- Receive at minimum 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate
- Pay a minimum of 90% percent of its taxable income in the form of shareholder dividends each year
- Be an entity that is taxable as a corporation
- Be managed by a board of directors or trustees
- Have a minimum of 100 shareholders
- Have no more than 50% of its shares held by five or fewer individuals
REITs typically fall within three categories:
- Most REITs are equity REITs. Equity REITs invest in and own income-producing real estate properties and give investors the opportunity to invest in these portfolios.
- Mortgage REITs invest in and own property mortgages. These REITs loan money to real estate owners and operators not only for mortgages but also for different types of real estate loans or through purchasing mortgage-backed securities. Their earnings are generated primarily by the net interest margin, the spread between the interest they earn on mortgage loans and the cost of funding these loans. This model makes them potentially sensitive to interest rate increases.
- Hybrid REITs invest in both properties and mortgages.