By Gary Meeks, RICP®
REITs have always provided investors with dividend-based income at competitive rates and potential tax advantages.
What is a REIT or Real Estate Investment Trust? Wikipedia has a good definition: a real estate investment trust is a corporation that owns and, in most cases, operates income-producing real estate. REITs own many types of commercial real estate, including office and apartment buildings, warehouses, hospitals, shopping malls, hotels, and commercial forests. Some REITs engage in the financing of real estate and hold real estate mortgages (Mortgage REITs).
REITs can also offer tax advantages. The Tax Cuts and Jobs Act 2017 allows the transfer deduction for REIT investors. This means that REIT investors can deduct up to 20% of their dividends.
REITs, like many companies, distribute profits to investors in the form of dividends. Unlike many companies, however, REIT income is not taxed at the corporate level. This means that REITs avoid the dreaded “double taxation” of corporate tax and personal income tax. Instead, REITs are sheltered from corporate tax, so their investors are taxed only once. This is one of the main reasons income investors value REITs over many other dividend-paying companies.
The tax code requires REITs to meet certain standards to qualify their shareholders for the tax benefits mentioned above. One such standard is the 90% rule, which requires REITs to pay out at least 90% of their earnings as dividends.
Some common REIT alternatives are traded REITs, non-traded REITs, and exchange-traded funds (ETFs) and REIT mutual funds.
A REIT stock is a company that owns or finances real estate. They trade on the stock exchange like other stocks. You should do your research before buying REIT stock.
The advantages of a REIT ETF (exchange-traded fund) are that they are diversified and professionally managed like a mutual fund, but have greater liquidity than a mutual fund. They trade like stocks, usually instantly, while mutual fund purchases or liquidations get the closing price for that trading day. The ETF also generally has a more tax-efficient structure and lower operating expenses than most mutual funds.
An unlisted REIT does not trade on an exchange but must still file with the SEC and is therefore regulated. Because they don’t trade on an exchange, they are less liquid than some of the other REIT options, and redemption opportunities may be limited.
Many brokers provide access to non-traded REITs and can help you find the right program for your needs. Most brokers require investors to meet minimum financial standards to buy an unlisted REIT. REITs are considered an alternative investment to stocks and bonds and therefore offer diversification, which can potentially reduce risk to your overall investment portfolio.