Real Estate Investment Trust (REIT) is an organization that engages in financing and investing in real estate directly, either through mortgages or properties thus generating a high level of income, diversification and long-term capital appreciation for investors. This article educates us on the function of REITs.
REITs are modeled after mutual funds in terms of receiving special tax considerations. This is because the fundamental part of the original REIT legislation mandates that all taxable income should be paid as dividends to shareholders after expenses have been deducted from corporate taxable income.
In turn, shareholders are expected to pay the income taxes on the dividends. The dividend distribution is done this way to ensure that REITs continue to deliver the expected income and perform at the standard characteristic of real estate debt and equity investment, as well as to guarantee that investors get the appropriate and approximate investment return if they owned the properties directly.
There are two major types of REITs, which are Mortgage REITs and Equity REITs, thus giving investors the option of investing in either the debt financing or the equity financing of real estate.
Some REITs however combine the strategies of Equity and Mortgage REITs by investing in both properties and mortgages. These REITs are referred to as Hybrid REITs.
Mortgage REITs principally invest in commercial and/or residential real estate mortgages and mortgage-backed securities. They operate by providing finance in terms of a loan to mortgage owners of real estate or by buying existing mortgage-backed securities thus making profit through the sales of the mortgages or the interest earned from these investments.
Profit, is, however announced after funding costs to buy mortgage investments and all other costs have been deducted from the income.
Equity REITs invest in and purchase properties consequently making them responsible for the value or equity of their real estate assets.
Usually, they invest in commercial properties, such as, shopping malls, apartment buildings, office buildings etc. and lease these structures out to tenants thereby making income through the collection of rent and sales of properties they own for the long-term. Equity REITs pay out on a yearly basis, the bulk of the income they make to their shareholders as dividends and sometimes, the dividends paid is inclusive of capital appreciation from the sale of properties.
REITs are expected to have certain attributes or characteristics in their mode of operation and investments which are income, transparency, diversification, liquidity, and investment performance and inflation protection.