Real Estate Investment Trust: Types and Risks of REITs

What is a real estate investment trust?

Real estate investment trust or REITs are companies that own and operate income-producing real estate or related assets. These include office buildings, commercial apartments, hotels, warehouses, mortgages, loans, etc. The companies’ goal is to buy and develop properties to operate them as part of its own investment polio. REITs provide a way for an investor to earn a share of the income produced through commercial real estate ownership. This means an investor doesn’t need to buy commercial real estate themselves.

Types of REITs

REITs that are registered with the SEC and are publicly traded on a stock exchange are known as publicly-traded REITs. Others that may be registered with the SEC but are not publicly traded are known as Non-Traded or Non-exchange REITs. Before investing in a REIT, you need to understand whether or not it is publicly traded and how it could affect your business.

Risks of REITs

The benefit of REITs is that it offers a way to include real estate in your investment portfolio. Some REITs may offer higher dividend yields than other investments. However, there are some risks especially with non-traded REITs:

1. Non-exchange REITs investments can’t be sold easily. If you need to sell to get quick money, non-traded REIT wouldn’t be a good choice for you.

2. While the market price of publicly traded REIT is accessible, non-traded REIT doesn’t give access in terms of determining the value of a share. Non-traded REITs do not provide an estimate of their value per share until 18 months after their offering closes. This means you aren’t going to assess the value and volatility immediately after investing.

3. Although non-traded REITs offer high dividend yields compared to public traded REITs, it frequently pays distributions over their funds from operation. To do that, they may use offering proceeds and borrowing. This practice reduces the value of the shares and the cash available to the company for purchasing extra assets.

4. Non-traded REITs have an external manager instead of their employees and this can lead to potential conflicts of interests with the shareholders.

Buying and selling REITs

You can invest in a publicly-traded REIT by purchasing shares through a broker. Similarly, you can purchase shares of a non-traded REIT through a broker that takes part in the non-traded REIT’s offering. You can also buy shares in REIT mutual fund or exchange-traded fund.

Fees and Special Tax Considerations

You can purchase the common stock, preferred stock, or debt security of a publicly-traded REIT through a broker. However, brokerage fees will apply for that. Non-traded REITs are not sold by a broker. It has high up-front fees. Sales commissions and upfront fees usually sum up to approximately  9 to 10 percent of the investment

Most REITs pay at least 100 percent of their taxable income to their shareholders. The shareholders of a REIT are responsible for paying the tax on the dividends and any capital they gain with their investments. Dividends paid by REITs are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends. Always consult your tax adviser before investing.

You can verify the registration of both publicly traded and non-traded REITs using SEC’s EDGAR system. You can also use it to review a REIT’s annual and quarterly reports as well as any offering prospectus.

This article was originally posted in: Paperfree.com