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What is a REIT– Why should I care?

by Nate Higgins, M.S., MBA

Imagine a way in which you could own a part of skyscrapers, vast swathes of farmland, or even a portion of tens of thousands of apartment units. In today’s day and age, this is a very achievable objective. In fact, with a brokerage account, one could obtain exposure to these asset classes in a matter of minutes. However, this wasn’t always the case. At one time, only high net worth individuals and large pension and private investment funds had access to these types of real estate assets. That changed in 1960 when President Dwight D. Eisenhower signed into law the Cigar Tax Extension Act, also known as Public Law 86-779. Overnight, this gave the everyday investor access to institutional grade real estate through the creation of an investment vehicle known as the Real Estate Investment Trust or (REIT).

All of a sudden the common investor could invest in a skyscraper or portfolio of properties with as little as a few hundred dollars. Investors now had access to income producing real estate through a vehicle very similar to a mutual fund. This was groundbreaking and changed the investing landscape in a variety of ways:

  • Investors had access to real assets in a liquid vehicle (meaning they could readily buy or sell their interests in the REIT)
  • The everyday investor now had a way to diversify their real estate holdings across both asset classes and geography
  • Investors could gain the advantages of investing in real estate without the hassle of sourcing a deal, performing due diligence on the property, or arranging financing

 The investors weren’t the only ones to benefit from this newly created investment structure.  Infrastructure investment in the United States saw a dramatic increase in the next decades as the newly formed REITs pooled investor capital to create new railroads, office parks, apartment buildings, warehouses, amongst other real estate assets. This allocation of capital allowed the United States to see a boom in construction, which created jobs, an increase in tax revenue, and provided investors with a less volatile, inflation hedged stream of income.

When Real Estate Investment Trusts were created in 1960, they came with regulations that were associated with their operation. These rules include:

  • REITs must pass through at least 90% of their income to investors in the form of dividends
  • Invest at least 75% of its assets in real estate or cash (includes US Treasuries
  • Derive at least 75% of its income from real estate (including rents received and the sale of property)
  • Have shares that are fully transferable
The key tax related element that makes REITs attractive, is that unlike a corporation where income is taxed at both the company level (income) and distribution level (dividends), REITs are only taxed at the distribution level (provided that the entity follows the rules established by Congress). This means that investors are receiving at least 90% of the income provided by the portfolio of properties, and this “90%” is going to be a greater amount than it normally would be outside of a REIT structure, because the income has not been taxed at the company level. Additionally, from a fee standpoint, this makes the REIT a rather investor friendly vehicle.

  

Well, that’s great Nate. Why should I care? In a time of historically low interest rates, it is difficult for  investors to find stable sources of income that are neither distressed nor overvalued. The dividend yield on the S&P 500 is below 2% and bond yields - even amongst distressed issuers - have fallen to near all-time lows. As values have soared in equities and fixed income, it has become increasingly difficult for investors to find both value and cash flow - two elements critical in the preservation of capital, portfolio growth, and income. Also, as interest rates continue to remain low, the value of real assets will begin to rise as inflation increases. Real Estate as an asset class is an excellent way to participate in this rise.

 

Real Estate Investment Trusts give individuals the ability to source inflation protected, tax advantaged income that provides diversity from the highly appreciated bond and equity markets. It empowers investors by giving them a historically less volatile way to achieve investment objectives. Stocks and bonds are not the only games in town available when it comes to growing one’s wealth. Additionally, some REITs utilize an accelerated depreciation schedule that allows the dividend to be much more tax advantaged than dividend income that is achieved through traditional equities or bonds. As an investor in the REIT you can achieve both growth from the appreciation of the real estate held by the REIT as well as the dividend income that is derived from rent.

REITs should not be the only asset that an investor utilizes, but they do provide one more option for the investor looking for preservation of capital, income, and growth. Contact Equilus Capital Partners for further information.