REIT's...The Basics Of Real Estate Investment Trust's
The real estate market can be one of great investment opportunity even for the average investor should the timing be right. Real estate like any asset class is cyclical in its behavior, and can present short term as well as long term opportunities. Many investors have opted to buy individual properties for the purpose of not only residing in or vacationing to, but also with the intent of renting to generate a cash flow. Yet whether you are talking about a residential or commercial property, becoming a landlord can be accompanied with a number of headaches. Not all real estate investors are interested in getting a call that the plumbing is leaking, and you’ll need to have a professional there immediately or fix it yourself. That type of overhead can cost you both in terms of capital as well as your valuable time, and should be considered when looking at any investment. Additionally, due to the higher overall initial minimum investments along with the ability to obtain financing…many would be investors are priced out of the market.
There can be an easier way. Real Estate Investment Trust’s (REIT’s) present and opportunity for individual investors to add real estate exposure to their investment portfolio without the time and commitment often required in making a direct investment in an individual property. REIT’s are securities that typically trade like a stock on an exchange that individual investors can purchase into at any time, which are organized in the form of a Unit Investment Trust. They can be broken down into two core categories.
An equity REIT will purchase and own individual properties which will generate a cash flow via the rentals which eventually pass thru to the shareholders in the form of a dividend. Additionally, the ownership of an equity REIT provides the shareholder the opportunity for capital appreciation in the value of the underlying real estate which may eventually be sold for a profit. Some equity REIT’s may have a specific concentration in certain areas of the market such as hospitality properties or shopping malls. While others are extremely diverse in their property holdings.
A mortgage REIT is an investment which exercises ownership in the underlying mortgages of the real estate owners. Rather than owning equity in a property, the mortgage REIT shareholder is a creditor of the property owner. They effectively hold the note on the property the same way a bank would hold the note on your home. Because the mortgage REIT market is more of a fixed income investment, it will typically be accompanied by higher dividend payments and less opportunity for capital appreciation.
Special Tax Treatment
The dividend income received by a REIT is typically taxed as ordinary income and will be taxed at the shareholders top marginal tax rate. The advantage is that unlike the stock of an individual company which must pay tax first at the corporate level and then again at the individual level, a REIT will only pay the tax at the individual level. The reduced layer of taxation often means a higher cash flow to the shareholder. Additionally, a portion of the dividend payment received by the shareholder can be deemed a Return of Capital to the shareholder. This means that this portion of the payment is treated as tax free while deferring the capital gain on the underlying assets further into the future.
While a REIT will typically hold multiple properties in the investment trust, some investors may seek greater diversity. As a result, REIT’s can be purchased via mutual funds for professional management, or exchange traded funds (ETF’s) for a lower cost passive approach to investing.
What’s most important to note is that real estate is just one of many asset classes that make up a more complete portfolio for a longer term investment strategy. However, regardless of one’s personal views on the shorter term investment opportunities currently presented by the real estate market, the REIT marketplace can often fill the void for the average investor as a simplified solution with some added tax benefits that will allow for diversified participation.
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