Real Estate Investment Trusts (REITs)

The Basics:

At its most basic form, a Real Estate Investment Trust (REIT) is essentially a corporation that owns various forms of real estate or interests in real estate. REITs allow a company to use the combined money from a group of investors in order to purchase real estate property. REITs can publically or privately held and they can be traded on the stock market, or not traded on the stock market, and thus, highly illiquid. Those that trade on the market (publically held traded REITs) are treated like mutual funds or securities investments and are listed on the national securities exchange Those that are not traded on the stock market (non-traded REITs) are not listed on the national securities exchange and often include a much higher risk for investors.

Generally speaking, there are three types of REITs:

  • Equity REITs: Through an equity REIT, investors own a piece of real estate (usually a residential, industrial or retail property) and generate revenues by renting the spaces out. For example, a REIT in a company that owns an apartment complex makes money by renting out those apartments to tenants.
  • Mortgage REITs: Mortgage REITs allow investors to own the mortgages on a piece of property, purchase additional mortgages from investors or loan mortgages to other investors. Investors raise revenue in these REITs from the interest on the mortgage itself. Unlike an equity REIT, a mortgage REIT owns no physical property
  • Hybrid REITs: Hybrid REITs are exactly what they sound like. They are investments that combine both equity and mortgage REITs. This REIT generates revenue from both the rent and capital gain on a piece of property as well as the interest on the mortgage.

The Benefits:

REITs offer investors the opportunity to purchase property they otherwise would not have the capital to buy such as commercial property, malls, apartment complexes, etc. Because all of the investors’ money is placed into one pool, large investors and small investors are placed on equal footing.

Additionally, because some REITs can be bought and sold like mutual funds or securities on the stock exchange, the cost of buying and selling them is significantly lower than what buying or selling the actual real estate would be.

Finally, by law, in order to qualify for special IRS tax exemptions, REITs must pay out 90% of their profits as dividends to their investors. REITs generally have a high yield (in September 2012, the average dividend yield was 4.3%).

The Detriments:

The Financial Industry Regulatory Authority (FINRA) has issued a warning to investors who have invested in, or are considering investing in, REITs. Specifically, FINRA warns, “When it comes to investing in non-traded REITs, selling points such as the opportunity for capital appreciation, diversification and the allure of a robust distribution can be enticing. But investors should balance these selling points against the numerous complexities and risks these investments carry.” For example, non-traded REITs have no public trading market. As a result, they are illiquid investments meaning it may be difficult to sell quickly at a price even close to its market value.

Given the high risk nature of these investments, investors should note that non-traded REITs are almost never suitable for short term investors and in most cases, even long term investors, unless they are willing to assume the great risk of illiquidity.

Additionally, while REITs do not pay taxes at the corporate level, they are still taxed on an individual level, resulting in property taxes that can be as high as 25% of the total operating expenses.

Investors should be wary of the seemingly appealing and simple reasons to invest in a REIT. When it comes to investments, if it seems too good to be true, it probably is. Stockbrokers and investment advisors who emphasize the high yields and stability of the dividends without mentioning the significant risk of illiquidity should be reported immediately.

If you or someone you know has lost money in a REIT, please contact the securities and investment fraud law firm of Fitapelli Kurta. We prosecute cases nationwide on behalf of investors who have been wronged by stockbrokers or broker-dealer firms. Do not wait. Time is of the essence in these claims and the law provides you with a limited window of opportunity to recover. Contact us today for your free consultation.

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