Real Estate Investment Trusts, more commonly known as REITs, were first created in the US in the 1880s.  Because of a tax reform in the 1930s they became effectively obsolete until Eisenhower passed the Real Estate Investment Trust Act in 1960.

Since then countries such as France and Japan have successfully implemented legislation to allow for the successful operation of similarly structured entities.  In 2006 Germany and Britain are expected to introduce their first REITs based on the US international standard.

This article answers frequently asked REITs questions.

What are REITs?

Real Estate Investment Trusts are corporations that purchase, develop, manage and sell property assets.  Individual investors can own shares in the REIT and benefit from large, professionally managed and operated property portfolios that they would not otherwise have access to.

The US has created an international standard for REITs where no tax is levied at the corporate or vehicle level.  These REITs are known as ‘pass-through entities’ which means that they simply act as a middleman for the distribution of profits and income to investors and their main business activities are limited to the generation of income from property through rental and letting. 

A fully compliant REIT therefore avoids taxation at the corporate level.

Most Real Estate Investment Trusts trade on major stock exchanges and are entities that generally invest in commercial property such as office or apartment blocks, industrial buildings and shopping centers.

How Do Corporations Qualify as REITs?

Britain and Germany are currently revising their legislation for the introduction of REITs in 2006 and as nothing has been officially finalized yet, the legislation discussed in this article relates to the US international standard for REITs on which Britain and Germany are believed to be basing their structuring.

A corporation has to annually prove it complies with the following rules in order to qualify as a pass through entity and achieve special tax status: -

1) The REIT must be structured as a corporation, a business trust or similar.
2) All shares have to be transferable without restriction.
3) The REIT must pay out at least 90% of its taxable income in dividends to its shareholders.
4) A minimum of 75% of investment assets must be in property, mortgages, cash, government securities or in the shares of other REITs.
5) At least 75% of gross income earned must come from rent, mortgage interest or from selling real estate assets.
6) The REIT must have a minimum of 100 shareholders.
7) Only a maximum of 50% of the REITs shares can be held by five or fewer individuals during the last six months of each taxable year.

If a corporation qualifies then it carries out its investment activities tax free.

Why Are REITs So Popular?

Whenever the phrase ‘tax free’ is bandied about the popularity of a qualifying vehicle will likely intensify.  Add to this the fact that the global property investment market has boomed in recent years providing many REIT investors with impressive dividends and you will understand why consequently REITs have become one of the fastest expanding areas of the stock market since the dot.com.

General Benefits and Advantages of REITs

There are great compound growth advantages to an investment that avoids double taxation but aside from these obvious benefits a REIT is also attractive for the following reasons: -

Generally speaking there is no minimum investment required to buy into a REIT which means that any investor can have access to a large, well managed and professional real estate portfolio. 

Buying into a REIT can significantly reduce an investor’s personal risk in two ways.  Firstly if the investor wanted access to similar assets directly he would have to personally invest significant capital into slow to liquidize real estate and bank on his entire investment being successful - not ideal.  The second alternative is that he borrows the capital required and gives personal guarantee for the loan thus exposing himself to further risk again.  A REIT removes these risks.

A REIT’s performance is based on the value of its underlying real estate assets making it a less volatile alternative to many standard stocks and shares and providing a degree of inflation proofing for investors. 

The income investors drawn from the REIT in the form of dividends is regular, relatively stable and often attractive and all REITs pay dividends unlike many other forms of investment.

Unlike the underlying physical real estate assets of a REIT, shares held in REITs traded on the major stock exchanges are highly liquid.  An investor can sell out easily to release cash and buy in easily to benefit.

And finally, according to the US international standard for Real Estate Investment Trusts, investors benefit from the regular monitoring of the REIT by independent directors, market analysts, auditors and of course the media.