REITs 101: 3 Questions to Help You Better Understand Real Estate Investment Trusts

A Real Estate Investment Trust (REIT) is a vehicle designed to give everyday investors the opportunity to access professionally managed real estate properties, without the hassle. Similar to a mutual fund, a REIT is a pooled investment fund, but it invests in various real property such as residential, industrial, retail, office, mortgage lending and other types of real estate debt or properties. 

For those unfamiliar with REITs, whether you are an investor or a fund manager, below provides a high level look at this unique fund and its important benefits.

1. What is a REIT?

A REIT allows investors exposure to real estate investments without directly owning, operating or financing properties themselves, and without the high cost associated with entering the real estate market. The IRS defines a REIT as a corporation, trust or association that:

• Is managed by one or more trustees or directors, 
• Is owned by 100 or more persons, 
• Has a calendar year-end,
• Is not closely held and
• Can be a publicly traded, public non-traded or private entity. 

A REIT is required to distribute the majority of its income to investors. As such, investors receive dividends via rent from tenants and interest from real estate backed debt. The REIT then gets a tax deduction for that distribution and generally avoids entity level taxation.

2. What are the Benefits of a REIT Structure?

Generally, REITs offer investors exposure to the real estate market and, therefore, an opportunity for diversification of their investments. Other benefits include:

• No Entity Level Tax. A REIT that meets its compliance requirements generally does not pay corporate income tax.   
• Blocker for Certain Tax Items. REITs pay dividends to their shareholders that are reported on Form 1099-DIV. However, REIT investors do not have to deal with Schedule K-1s and state compliance generally associated with real estate holdings. 
• Market Access. A REIT has access to a broad pool of investors, and the average investor enjoys relatively easy access to the often complex real estate sector. 
• Potential Liquidity. As opposed to direct investment in real estate, publicly traded REIT shares are readily traded on the market. 
• Transparency. The oversight and compliance associated with REITs generally provide investors with extra protection.
• Extra (albeit temporary) 20% Deduction for Investors. Section 199A of the tax code provides an added benefit to REIT investors, allowing REIT shareholders to deduct 20% of their REIT income — tax free — until Section 199A sunsets in 2025. 

3. How Does a Fund Qualify as a REIT?

Compliance is key. If a fund qualifies as a REIT, no entity level tax is paid. To reap this and other benefits, a REIT must comply with certain regulatory requirements: 

• Annual 95% Gross Income Test. Generally, at least 95% of the REIT entity’s gross income must come from the following sources:
  • Dividends
  • Interest
  • Rents from real property
  • Mortgage interest
  • Gains from sale of real property
  • Certain mineral royalty income
• Annual 75% Gross Income Test. Generally, a REIT needs to satisfy this test by deriving 75% of its gross income from the following sources:
  • Rents from real property
  • Mortgage interest
  • Gains from sale of real property
  • Dividends and/or gains from sales of other qualified REITs
• Quarterly Asset Test. At least 75% of the value of the REIT’s total assets must be represented by real estate assets, cash and cash equivalents, and government securities. 

REITs are complex investment vehicles, but they can be a beneficial way to tap into the real estate market — for both investors and fund managers alike.

Contact Pargat Singh at psingh@cohenco.com, Andreana Shengelya at ashengelya@cohenco.com or a member of your service team to discuss this topic further.

Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.