Real estate investment trusts(REIT’s)

The Basics Of REIT Taxation

A Real Estate Investment Trust (REIT) is a tax designation for a corporation investing in real estate reducing or eliminating corporate income taxes.Real estate investment trusts (REITs) have established themselves as a means for the smaller investor to directly participate in the higher returns generated by real estate properties. Like every other company, REIT can be publicly or privately held where publicly held REIT is listed on public stock exchanges. REIT, which is publicly traded, is required to file reports with the Securities and Exchange Commission (SEC) in the American system. The key statistics to observe in case of REIT are Net Asset Value (NAV), Adjusted Funds From Operations (AFFO) and Cash at Disposal (CAD).In the past, these trusts were considered to be minor offshoots of unit investment trusts, in the same category as energy or other sector-related trusts that had been created, but when the Global Industry Classification Standard granted REITs the status of being a separate asset class the rules changed and their popularity soared.

Basic Characteristics of REITs
REITs are a pool of properties and mortgages bundled together and offered as a security in the form of unit investment trusts. Each unit in an REIT represents a proportionate fraction of ownership in each of the underlying properties. These investment vehicles constitute approximately 10% of the financial sector and nearly one-quarter of the domestic equity sector. In 2007, nearly 200 REITs were traded actively on the New York Stock Exchange and other markets.

Typically, REITs tend to be more value than growth-oriented, and are chiefly composed of small and mid cap holdings.

The IRS requires REITs to pay out at least 90% of their incomes to unitholders (the equivalent of shareholders). This is similar to corporations, and means REITs provide higher yields than those typically found in the traditional fixed-income markets. They also tend to be less volatile than traditional stocks because they swing with the real estate market. (To learn about REIT valuation, see Basic Valuation Of A Real Estate Investment Trust.)

Three Types of REITs
REITs can be broken down into three categories: equity REITs, mortgage REITs and hybrid REITs.

• Equity REITs – These trusts own and/or rent properties and collect the rental income, dividends and capital gains from property sales. The triple source of income makes this type very popular.
• Mortgage REITs – These trusts carry a greater risk because of their exposure to interest rates. If interest rates rise, then the value of mortgage REITs can drop substantially. (To learn more, see The Impact Of Interest Rates On Real Estate Investment Trusts and Behind The Scenes Of Your Mortgage.)
• Hybrid REITs – These instruments combine the first two categories. They can be either open- or closed-ended (similar to open- and closed-ended mutual funds), have a finite or indefinite life and invest in either a single group of projects or multiple groups.