What Is a REIT? — In Plain Words

This page is educational only. It is not financial advice.

What a REIT is

A real estate investment trust (“REIT”) is a company that owns and typically operates income-producing real estate or related assets.

Those assets may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans.

Unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties primarily to operate them as part of its own investment portfolio.

The two types of REITs

Many REITs are registered with the SEC and are publicly traded on a stock exchange. These are known as publicly traded REITs.

Others may be registered with the SEC but are not publicly traded. These are known as non-traded REITs (also known as non-exchange traded REITs).

The SEC page calls this one of the most important distinctions among the various kinds of REITs: whether or not a REIT is publicly traded can affect the benefits and risks to you.

The benefits, as the SEC states them

REITs offer a way to include real estate in one’s investment portfolio.

Additionally, some REITs may offer higher dividend yields than some other investments.

The special risks of non-traded REITs

There are some risks, especially with non-exchange traded REITs. Because they do not trade on a stock exchange, non-traded REITs involve special risks:

• Lack of liquidity: Non-traded REITs are illiquid investments. They generally cannot be sold readily on the open market. If you need to sell an asset to raise money quickly, you may not be able to do so with shares of a non-traded REIT.
• Share value transparency: While the market price of a publicly traded REIT is readily accessible, it can be difficult to determine the value of a share of a non-traded REIT. Non-traded REITs typically do not provide an estimate of their value per share until 18 months after their offering closes. This may be years after you have made your investment. As a result, for a significant time period you may be unable to assess the value of your non-traded REIT investment and its volatility.
• Distributions may be paid from offering proceeds and borrowings: Unlike publicly traded REITs, non-traded REITs frequently pay distributions in excess of their funds from operations. To do so, they may use offering proceeds and borrowings. This practice, which is typically not used by publicly traded REITs, reduces the value of the shares and the cash available to the company to purchase additional assets.
• Conflicts of interest: Non-traded REITs typically have an external manager instead of their own employees. This can lead to potential conflicts of interest with shareholders. For example, the REIT may pay the external manager significant fees based on the amount of property acquisitions and assets under management. These fee incentives may not necessarily align with the interests of shareholders.

Fees

Non-traded REITs generally have high up-front fees. Sales commissions and upfront offering fees usually total approximately 9 to 10 percent of the investment.

These costs lower the value of the investment by a significant amount.

Taxes

Most REITs pay out at least 100 percent of their taxable income to their shareholders.

The shareholders of a REIT are responsible for paying taxes on the dividends and any capital gains they receive in connection with their investment in the REIT.

Dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends.

Avoiding fraud

Be wary of any person who attempts to sell REITs that are not registered with the SEC.

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

This page is educational only. It is not financial advice.