What Is a REIT?

A REIT, also known as a Real Estate Investment Trust, is a kind of security where the business owns and typically manages real estate or other tangible estate-related assets. REITs are akin to stocks and are traded on the major exchanges. REITs permit companies to purchase mortgages or real estate investing in an investor pool. This type of investment enables both small and large investors to hold real estate shares, without buying or managing the real estate itself.

REITs generally have to have at minimum 100 investors. These regulations stop a possible nefarious way of doing it by having fewer investors hold most of the shares of REITs. 1

At least 75% of a REIT’s assets should be real estate, and at the minimum, 70% of their total earnings must come from mortgage interest, rents, or the selling or lease of property. 1

Additionally, REITs are required legally to pay at least 90% of their annual tax-deductible income (excluding capital gains) to shareholders in the form of dividends. This limitation does not limit the REIT’s ability to use internal cash flow to grow for growth purposes. 1

KEY TAKEAWAYS

• REITs are firms that manage, own, or finance income-producing properties.
• Equity REITs tend and hold properties and generate income primarily through rental income.
• The Mortgage REITs are invested in mortgage-backed securities and related assets and earn revenue from the income from interest.

Equity REITs

Equity Real Estate Investment Trusts are the most well-known kind of REITs. They purchase the property, manage it, build renovations, sell, and build properties that generate income. Most of their revenue comes from rental payments from their real estate properties. An equity REIT could invest across a wide range or concentrate on a particular sector.

Equity REITs generally generate steady income. Since these REITs earn rents that they collect, their income is simple to forecast and increases over time.

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Mortgage REITs

Mortgage REITs–also called mREITs, invest in mortgages, mortgage-backed securities (MBS), and related assets. While equity REITs usually generate revenues by renting out their properties, Mortgage REITs earn revenue from the interest they earn on their investments.

For example, suppose that the company ABC is considered a REIT. It acquires an office property using the money it receives from investors and rents office space. Company ABC is the owner and manager of the real estate property and pays rent every month to its tenants. Company ABC is therefore regarded as a REIT with equity.

However, imagine that the company XYZ is a REIT that lends money to an agent for real estate development. Contrary to the company ABC, XYZ earns money through the interest it makes from the loans. The company XYZ is a REIT for mortgages.

As with equity REITs, most mortgage REIT’s earnings are distributed to investors as dividends. Mortgage REITs generally perform much better than equity REITs in times when rates of interest are increasing.

Risks of Equity and Mortgage REITs

Like any other investment Equity REITs, mortgage REITs carry their risk factors. Here are a few of them that investors need to take note of

• Equity REITs are generally cyclical and may be sensitive to recessions and economic decline.
• In the case of equity REITs, excessive supply, for example, the addition of more hotel rooms than the market could accommodate–may result in higher rates of vacancies and lower rental income.
• The changes in interest rates could influence the payment of mortgage REITs. In the same way, lower rates could cause more homeowners to refinance or even repay their mortgages. The REIT will have to invest at a lower interest rate.
• The majority of the mortgage securities REITs purchase are guaranteed by federal authorities, reducing the credit risk. However, some REITs might be more vulnerable to credit risk based on the particular investments.

The Bottom Line

REITs offer investors the opportunity to gain access to the market for real estate without having to purchase or manage the properties themselves. Both mortgage and equity REITs must give 90% of their earnings to shareholders as dividends. The payouts tend to be higher than those for shares. 1

Equity REITs can appeal to buyers looking for a blend of income and growth. Mortgage REITs are more suitable for risk-averse investors seeking maximum payment with no attention to capital appreciation.