Likewise, private REITs are sold by private placement and cannot easily be offloaded except during certain times for prices set by sponsors. Private REITs are somewhat more complicated. They typically are limited to institutional investors and accredited investors who can directly access the funds or reach them via private networks.
They also usually carry much higher minimum investment requirements and can be much harder to offload. REITs can be a good addition to your portfolio because they often perform independently of stock and bond markets. This can make them a good diversifier for your asset allocation.
Because they typically pay high dividends, REITs can provide income to investors looking for cash flow, and they offer an opportunity for investors who want to get involved in large-scale real estate investment without the hassle of individual purchases. REIT dividends are usually taxed as ordinary income. I'm a freelance journalist, content creator and regular contributor to Forbes and Monster.
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Be an entity that is taxable as a corporation. Be managed by a board of directors or trustees. Have a minimum of shareholders. You might consider investing in a REIT for a few key reasons: Get Exposure to Real Estate One of the primary reasons to invest in REITs is the exposure they provide to real estate—residential, commercial or retail—without requiring you directly purchase individual properties. Was this article helpful?
Share your feedback. One of the best ways to receive passive income from REITs is through the compounding of these high-yield dividends. As with any investment, there is always a risk of loss.
Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds. Investing in certain types of REITs, such as those that invest in hotel properties, is not a great choice during an economic downturn. Investing in other types of real estate such as health care or retail, however, which have longer lease structures and thus are much less cyclical, is a great way to hedge against a recession.
The federal government made it possible for investors to buy into large-scale commercial real estate projects as far back as However, only in the last decade have individual investors embraced REITs. Reasons for this include low-interest rates, which forced investors to look beyond bonds for income-producing investments, the advent of exchange-traded and mutual funds focusing on real estate and, until the real estate meltdown, an insatiable appetite on the part of Americans to own real estate and other tangible assets.
REITs, like every other investment in , suffered greatly. But despite this, they continue to be an excellent addition to any diversified portfolio. Accessed April 15, National Association of Real Investment Trusts. Securities and Exchange Commission. Real Estate Investing. Dividend Stocks. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.
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Investing in Rental Property. Alternative Real Estate Investments. Investing Strategies. Tax Implications. Alternative Investments Real Estate Investing. Table of Contents Expand. Retail REITs. Residential REITs. Healthcare REITs. Office REITs. Mortgage REITs. The Bottom Line. Some REITs invest directly in properties, earning rental income and management fees. Others invest in real estate debt, i.
In addition, REITs tend to focus on a specific sector of properties, for instance, retail or shopping centers, hotels and resorts, or healthcare and hospitals. Pros High-yield dividends Portfolio diversification Highly liquid. Cons Dividends are taxed as ordinary income Sensitivity to interest rates Risks associated with specific properties.
A REIT cannot be a financial institution or an insurance company and it must be managed by one or more trustees or directors. A REIT cannot be closely held. Spouses and certain other family members are aggregated and count as one individual for this purpose. A REIT is required to pay a dividend of at least 90 percent of its taxable income each year. A dividend is any distribution of cash or property made by a corporation to its shareholders out of its earnings and profits from the current taxable year and then from accumulated earnings and profits from prior years.
If there are no earnings and profits available for a distribution, the distribution is considered a return of capital for the shareholder and is therefore nontaxable to the extent the shareholder has basis in the REIT shares.
A REIT is subject to different income and asset tests. Real estate assets specifically include real property, interests in mortgages on real property or real estate mortgage investment conduits. Along with the asset tests, REITs must also comply with annual income tests. These income tests are based on the gross income from the various properties that the REIT owns. There are two income tests: the 75 percent test and the 95 percent test.
The 75 percent test is comprised solely of real estate income. Rents from real property is defined to include rents; charges for services customarily furnished in connection with rental of real property; and generally rent attributable to personal property which is leased in connection with a lease of real property. Impermissible tenant service income is excluded from rents from real property.
REITs must also comply with the 95 percent test. While this test has less margin for error, it also allows for a greater variety of sources of income. This test includes both real estate and portfolio income.
All of the real estate income from the 75 percent test is included in the 95 percent test. Interest income, dividend income, and gain from the sale or disposition of stock and securities are also included. A prohibited transaction is a sale or other disposition of property that is held primarily for sale to customers in the ordinary course of a trade or business.
Net income from prohibited transactions is taxed at percent for REITs. There are certain safe harbors to follow in order to avoid a sale being deemed a prohibited transaction. Prohibited transactions are a common issue about which REIT stakeholders must be aware because the penalties can be severe. Whether or not a REIT makes sense for your company depends heavily on the makeup of your investors and their preferences.
As noted, a REIT distributes earnings to shareholders in the form of a dividend. At the same time, the REIT is entitled to a dividends-paid deduction.
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