What are REITs

What are REITs?

A REIT (Real Estate Investment Trust) owns and usually operates income-generating real estate or related assets. These properties can include office buildings, shopping centers, apartments, hotels, warehouses, self-storage facilities, and even mortgages or loans. Most REITs focus on one type of real estate, such as residential buildings or healthcare facilities. What makes REITs different from other real estate companies is that they mainly buy and develop properties to hold and manage them for income, rather than selling them after development.

REIT Formation Process

• Basic Structure: To form a REIT, you can use various types of entities such as trusts, partnerships, LLCs, or corporations. The main requirement is that the entity must be treated as a corporation for tax purposes.

• Election to be a REIT: To officially become a REIT, the entity must choose this status by filing a special tax form (Form 1120-REIT). This choice must be made explicitly, even if the entity was eligible to be a REIT in previous years. Once this decision is made, it usually stays in effect unless it is revoked or terminated.

• Preferred Jurisdiction: Most publicly traded REITs are set up under Maryland law. This is because Maryland has specific laws that benefit REITs and is known for its expertise in REIT regulations. For example, Maryland law allows REITs to issue shares without needing money in return and makes it easier for the REIT’s board to make changes to its governing documents.

• Life Span: REITs can be set up to last forever or for a specific period. A finite-life REIT distributes money from sales or other sources to its investors and is dissolved when its term ends. A perpetual REIT keeps reinvesting money into new real estate projects and continues operating indefinitely.

Characteristics of a REIT

Income Distribution:

• Must distribute at least 90% of its taxable income to shareholders annually as dividends.

• This distribution allows the company to deduct those dividends from its taxable income, usually resulting in no corporate tax.

Shareholder Requirements:

• Have a minimum of 100 shareholders after its first year.

• No more than 50% of its shares can be held by five or fewer individuals during the last half of the taxable year.

Corporate Structure:

• Managed by a board of directors or trustees.

• Shares must be fully transferable.

Asset and Income Requirements:

• Invest at least 75% of its total assets in real estate assets and cash.

• Derive at least 75% of its gross income from real estate-related sources (e.g., rent, mortgage interest).

• Derive at least 95% of its gross income from real estate sources and dividends or interest from any source.

Asset Restrictions:

• No more than 25% of its assets can be in non-qualifying securities or stock in taxable REIT subsidiaries.