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Navigating Real Estate Investment Trusts (REITs): A Guide for Investors

“Diversify Your Portfolio and Maximize Returns with REITs”

Introduction

The recent stock and bond market cycle has been beneficial for many real estate investors; however, it has also led to high asset prices and low interest rates for traditional investments. As a result, some investors may be looking for ways to diversify their portfolio or increase their income yield.


Real estate can provide these benefits, but it can also come with significant work, fees and risk.


One way to invest in real estate without these issues is through a Real Estate Investment Trust (REIT). REITs can provide diversification and income benefits while also being tax efficient.


Consider including REITs in your portfolio.


What is a Real Estate Investment Trust or REIT?

A Real Estate Investment Trust (REIT) is a type of company that owns or operates real estate properties. It operates like other pooled investment vehicles, such as mutual funds, where investors can purchase shares and own a fraction of the underlying real estate portfolio.


REITs can be diversified, investing in various types of properties like apartments, office spaces, and industrial buildings or focusing on one specific type of property like multifamily apartments. Some REITs also engage in financing real property by issuing mortgages.


REITs were first established in 1960, allowing individual investors access to commercial real estate investment. The Tax Reform Act of 1986 also expanded the revenue streams available to REITs by allowing them to manage and operate real estate properties.


Timeline of REITs Listing by property type

The REIT industry has undergone changes over time, as illustrated below in the timeline below. One significant change occurred with the Tax Reform Act of 1986, which allowed REITs to not only own but also operate and finance a diverse range of property types.

REITs offer not only a liquid and cost-effective way to own real estate, but also potential tax benefits. As long as certain conditions are met, REITs are exempt from corporate income taxes, providing them an edge over taxable corporations. The following hypothetical example illustrates this advantage.

The tax benefits of REITs can be substantial, particularly for investors in a high tax bracket, as demonstrated in the example above. To qualify as a REIT, an investment vehicle must meet certain requirements:

  • Invest at least 75% of total assets in real estate

  • Generate at least 75% of gross income from real estate, interest on mortgages financing real estate, or sale of real estate

  • Distribute at least 90% of its taxable income as shareholder dividends annually

  • Organized as a corporation

  • Governed by a board of directors

  • Have a minimum of 100 shareholders

  • No more than 50% of shares held by five or fewer individual owners.

With the basics of REITs covered, let's delve into the different forms REITs can take.


What are the types of REITs?

REITs can be categorized based on various criteria:

  • Business activity: REITs can own and operate real estate (equity REIT), originate and hold mortgages on real estate (mortgage REITs), or both (hybrid REIT).

  • Property type: REITs can specialize in a specific type of property such as storage facilities, commercial buildings, residential developments, medical centers, senior housing or malls, or hold a diversified portfolio of different types of properties.

  • REIT structure: REITs can be publicly traded, public non-traded, or private. The following section will provide an overview of these structures.

Publicly Traded REITs

Publicly traded REITs constitute the majority of REIT assets. These companies are listed on the Nasdaq or NYSE, similar to traditional stocks, and are overseen by the U.S. Securities and Exchange Commission (SEC). Publicly traded REITs are required to file annual (10-K) and quarterly (10-Q) reports, as well as other mandatory filings. Shares of publicly traded REITs are highly liquid, as they can be bought or sold during the trading day.

Examples of publicly traded REITs include Public Storage (NYSE: PSA), Simon Property Group (NYSE: SPG), and AvalonBay Communities (NYSE: AVB). Additionally, there are also exchange-traded funds (ETFs) and mutual funds that provide exposure to a basket of REITs.


Public Non-Traded REITs

Public non-traded REITs (also known as public non-listed REITs/NPLRs) must register with the SEC, but shares are not publicly traded on an exchange. That means that shares in these REITs are illiquid, and investors may not be able to readily sell them without offering a significant discount.

Public non-traded REITs must still make regular filings, including quarterly and annual reports. Some non-traded REITs may offer periodic share repurchase windows, during which investors can liquidate their shares.


Private REITs

Private REITs are not traded on a stock exchange and are not registered with the SEC. Shares in these REITs are typically issued through exemptions under securities laws, such as Regulation D which allows issuers to sell shares to accredited investors and Rule 144A which allows issuers to sell to qualified institutional buyers.


Though these exemptions are set forth in laws enforced by the SEC, private REITs are not required to make regular regulatory filings. Investors will typically have the opportunity to review information about strategy, fees, and corporate structure through a private placement memorandum or other summary document.


The absence of reporting requirements can reduce compliance costs and administrative burdens for private REITs. Additionally, investments in private REITs are not subject to the fluctuations of the public equity markets, which can cause significant short-term price dislocations and result in the pursuit of strategies that do not maximize long-term shareholder value. In this sense, the lack of liquidity can be an advantage for investors who can tolerate an extended holding period.


Some private REITs may offer occasional share repurchases, but these securities are typically very illiquid. Similar to public non-traded REITs, private REITs may seek to gain liquidity after a specified period through an IPO, sale, or liquidation. However, in general, private REITs are illiquid investments that require a holding period of five years or more.


REIT Comparison

The table below highlights some of the key distinctions between the various types of REITs.


There are other variations between these structures, however, these major differences can serve as a foundation for an investor's research process.


Advantages and Disadvantages of REITs

Investing in a REIT offers several benefits:

Investing in a REIT also has some potential drawbacks:

Is A REIT Right For You?

An investor who is considering investing in a REIT should consider all the advantages and disadvantages of the REIT vehicle, as well as their own unique investment goals and needs.


A REIT may be a good fit for an investor who:

  • Is looking to diversify their portfolio beyond stocks and bonds.

  • Is bullish on real estate as an investment opportunity, but unwilling or unable to actively own and manage properties.

  • Wants to achieve diversified exposure to real estate as an investment, rather than just investing in a single property or a small number of properties.

  • Has an investment goal that is focused on capital preservation and income, rather than speculation or high capital appreciation.

  • Has a high marginal income tax bracket, thus increasing the value of the potential tax advantages of the REIT structure.

Additionally, a private REIT may be a good fit for an investor who:

  • Is an accredited investor, which typically requires net worth of $1 million or an annual salary of over $200,000 ($300,000 for couples).

  • Is willing to lock up their cash for a 5-10 year period, during which the investment would be generally illiquid.

  • Believes that the absence of regulatory filings and being less exposed to market volatility may create opportunities for managers to generate superior risk-adjusted returns.


Next Steps

If you are considering investing in REITs, please visit www.brazencap.com/alts/REITS for more information.


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