Real Estate Investment Trusts (REIT)

 

WHAT IS A REAL ESTATE INVESTMENT TRUST?

Of the estimated $55 trillion in capital wealth within the United States approximately forty percent consists of investment in real estate (Griffin Capital, WSJ) � including both personal residences and the nation�s supply of income-producing commercial properties. Multiple means exist by which to make an investment in real estate, and one popular vehicle is through a Real Estate Investment Trust, or REIT. Congress enacted REIT legislation in 1960 to allow an individual investor to combine capital with other investors to acquire or finance a diversified portfolio of large-scale, income producing real estate assets.

A REIT is a corporate designation which, to the extent it abides by specific rules and restrictions, is not required to pay corporate income taxes. All dividend distributions made by the REIT to its investors are taxed only at the investor level�thereby avoiding any �double taxation.�

In order to qualify as a REIT, an otherwise taxable domestic corporation must:

• Be managed by an independent board of directors or trustees;

• Be jointly owned by 100 or more stockholders with no more than five or fewer investors owning more than 50% of the REIT;

• Earn at least 95% of its income from dividends, interest, and property income;

• Pay dividends to its shareholders of at least 90% of the REIT's taxable income;

• Invest at least 75% of its assets in real estate; and

• Derive at least 75% of its gross income from rents or mortgage interest.  

 WHAT ARE THE TRADE-OFFS BETWEEN OWNING A PUBLIC AND A PRIVATE REIT?

Like any corporation, a REIT can either be privately held or publicly owned. If publicly owned, the REIT may have its shares listed on a stock exchange, or its shares may be unlisted. Though a publicly registered, unlisted, or non-traded, REIT is often referred to as �private REITs,� the non-traded REIT is a public company, required to file quarterly, annual and other reports with the Securities and Exchange Commission. There are certain trade-offs between owning a publicly traded REIT and a private or publicly registered non-traded REIT (collectively referred to herein as a �Private REIT�):

• The public, exchange-listed and traded REIT (�Public REIT�) is subject to the daily fluctuations of the market whereas the Private REIT�s share price generally does not change and can therefore be perceived as less volatile.

• Public REITs trade on an exchange and are therefore easy to sell whereas Private REITs have no such public market access and are therefore less liquid.

• Private REIT shareholders are typically compensated for the comparative lack of liquidity, relative to the Public REIT, through a higher percentage dividend return.

 RECENT COMPARATIVE PERFORMANCE

While publicly traded REITs have certain advantages such as liquidity, diversification and a much larger selection, from a purely performance perspective, if an investor had acquired a diversified portfolio of stocks at the end of 2003 as represented by the S&P 500 Index, over the course of the ensuing five years the investor would have been down 18.8%. Similarly, if that same investor had acquired a portfolio of diversified, public REIT stocks, as measured by the National Association of Real Estate Investment Trusts (NAREIT) index, the investor�s cumulative return, although hitting a high of 89.7%, would have ended the period down 2.3%. However, if that investor had purchased a private REIT, given the relatively constant share price and assuming the portfolio generated a market representative dividend yield of 6.75%, the investor would have earned over 38.6% during that five year period, a portion of which may represent a return of capital. This lack of pricing volatility in private REIT shares lends stability to the investor�s total return.