REIT Investing Basics

August 05, 2021

By Nicholas Mazzotti and Eric Kea

Just as many millennials are on the prowl for housing, financial institutions have logged onto Zillow as well. Although around since 1960, real estate investment trusts (“REITs”) have established themselves as a popular way for investors to diversify portfolios. Since real estate generally provides stable long-term gains, REITs can be a profitable way to reduce overall risk in a portfolio. To qualify as an REIT, a company must meet certain criteria, including but not limited to:

  • Hold at least 75% of total assets in real estate
  • Distribute via dividend at least 90% of taxable income
  • Earn at least 75% of gross income from the rent of real estate, mortgage interest, sale of buildings, or dividends from other REITs
  • Be a corporation managed by a board of directors or trustees
  • Have a minimum of 100 shareholders

The population of REITs fit into three distinct categories: equity REITs, mortgage REITs, and hybrid REITs. Equity REITs center on the ownership of apartment buildings, offices, hotels, warehouses, and other types of real estate. Mortgage REITs originate or purchase mortgage loans or mezzanine loans that qualify as mortgage loans for purposes of the REIT asset tests. A mortgage REITs business strategy will often be to borrow to finance their assets, with the interest rate on the borrowings being less than the interest rate earned on its assets.  Finally, hybrid REITs, as the name implies, are a mix of the two.  

Several key factors have impacted the real estate industry over the past decade.  These key factors have helped to make REITs all the more popular. Multifamily and industrial properties have steady growth rates since the 2008 financial crisis. Multifamily apartment buildings in particular have been particularly profitable, as the consequences of COVID-19 have pushed potential homeowners back into rental units. Additionally, since little construction progressed since the start of the pandemic, Equity REITs have thrived as competition in areas of ownership was scarce. However, the rising mortgage rates are a direct threat for Mortgage REITs.

Several tax benefits are reaped through the usage of REITs. Provided that the company meets the qualifications, the earnings will only be taxed at the shareholder level. Unlike traditional investments in stocks, no double taxation occurs, leaving more money in the pockets of shareholders. Additionally, individual shareholders generally have the ability to take a deduction against normal REIT dividends equal to 20% of the gross amount of the regular REIT dividends.

In closing, REITs have many potential positives to those who chose to invest in REITs after a discussion with their investment advisor.

About Eric Kea

Eric Kea is a Tax Partner in the Real Estate Services Group with over 25 years of public accounting experience.