What Is a REIT?

A REIT, which is a shortened form of real estate investment trust, is a kind of security where the business owns and typically manages real estate and real estate-related assets. REITs are akin to stocks and are traded on the major exchanges. REITs permit companies to purchase mortgages or real estate, making investments that are combined with investors. This kind of investment allows both small and large investors to hold shares of real estate without having to purchase or manage real estate on their own.

REITs generally have to have at minimum 100 investors. Regulations prohibit a possible nefarious way of doing it by having a smaller amount of investors own the majority of the shares within the REIT. 1

At a minimum, 75% of the REIT’s assets should be real estate, and at minimum, 75percent of the net income has to come from mortgage interest, rents, or gains from the selling of the real estate. 1

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

KEY TAKEAWAYS

• REITs are firms that own, manage, or finance properties that earn income.
• Equity REITs operate and own properties and earn revenue by way of rental income.
• They invest in mortgage REITs, mortgage-backed securities, and other assets and earn revenue from the income from interest.

Equity REITs

Equity REITs that invest in real estate are the most well-known kind of REITs. They purchase the property, manage it, build renovations, sell, and build properties that generate income. Their revenue is primarily generated through rental earnings on their real estate properties. An equity REIT can invest in a broad range of assets or concentrate on a specific sector.

They generally offer a steady income. Because they generate rents that they collect, their earnings are simple to forecast and are likely to grow as time passes.

Mortgage REITs

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

As an example, let’s say that a company, ABC is considered to be a REIT. It purchases an office building using the money it receives from investors and leases office space. Company ABC manages and owns the property, which receives rent each month from its tenants. Company ABC is thus categorized as a REIT that is equity-based.

However, suppose that the company XYZ is REIT and loans money to an estate developer. In contrast to the company ABC, the company XYZ earns money by earning interest on loans. The company XYZ is, therefore, a REIT for mortgages.

As with equity REITs, however, the majority of the profits from mortgage REITs are distributed to investors as dividends. Mortgage REITs typically perform more well than equity REITs in times when interest rates rise.

Risks of Equity and Mortgage REITs

Like any other investment, such as equity REITs and mortgage REITs carry their part of the risk. Here are some that investors need to know about:

• Equity REITs are typically, by nature, cyclical, and they can be sensitive to recessions as well as periods of economic recession.
• In the case of equity REITs, excessive supply, for example, the addition of more hotel rooms than the market is able to accommodate–can result in greater vacancies as well as lower rental income.
• The changes in interest rates could influence the payment of mortgage REITs. In the same way, lower rates could prompt more homeowners to refinance or even repay their mortgages. In turn, the REIT must reinvest at a lower interest rate.
• The Federal government guarantees the majority of mortgage securities REITs purchase. This helps limit the risk of credit. However, some mREITs could be more vulnerable to the risk of credit based on the particular investment.

The Bottom Line

REITs offer investors the opportunity to gain access to the market for real estate without having to purchase the property, manage it, or finance the properties themselves. Both mortgage and equity REITs must give 90% of their earnings to shareholders in the form of dividends. The payouts are usually higher than the dividends that are paid out by stock. 1

The general rule is that equity REITs could be appealing to investors who buy and hold, seeking a mix of income and growth. Mortgage REITs are better suited to risk-tolerant investors seeking maximum payment and without a lot of concentration on capital appreciation.

Is real estate a thing?

Real estate refers to land, as well as any permanent improvements that are attached to it, natural or made by humans, such as mineral deposits, water, trees, constructions, homes, fences, and bridges. It is the type that is actual property. It is different in comparison to personal properties, which are objects that are not permanently tied to the land, such as vehicles as well as boats, jewelry, furniture, and farm equipment.

What’s a mortgage-backed security (MBS)?

An MBS, also known as a mortgage-backed security (MBS), is an investment that is similar to a bond but comprised of a combination of home loans purchased from banks that issued these securities. Investors who invest in MBS receive regular payments that are similar to coupon payments for bonds. 2

Is trust a word?

Trusts are fiduciary arrangements where one person, called a trustor, grants a different party, named the trustee, the authority to own the title to assets or property to the benefit of an unrelated party, called the beneficiary.3 Trusts are created to protect legal rights for the trustor’s assets to ensure that the assets are distributed in accordance with the wishes of the trustor to help reduce paperwork and, in certain cases, to avoid or lessen taxes on inheritances or estate taxes.4 In the field of finance, the trust may also be a closed-end fund that is a public limited corporation.

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