- A real estate investment trust (REIT) is a corporation that owns, operates, or funds assets that generate revenue.
- REITs provide investors with a consistent income stream but little in the way of capital appreciation.
- The majority of REITs are traded on the stock exchange, making them extremely liquid (unlike physical real estate investments).
- Apartment complexes, cell towers, data centers, hotels, medical facilities, offices, retail centers, and warehouses are among forms of real estate that REITs invest in.
Are REITs liquid or illiquid?
REITs are a means to diversify one’s investing portfolio by including real estate. Furthermore, certain REITs may pay even greater dividends than conventional investments.
There are, however, inherent dangers, particularly with non-exchange traded REITs. Non-traded REITs have unique risks because they are not traded on a stock exchange:
- Non-traded REITs are illiquid investments due to their lack of liquidity. They are often difficult to sell on the open market. You may not be able to sell shares of a non-traded REIT to raise money quickly if you need to sell an asset.
- Investors may be drawn to non-traded REITs because of their relatively high dividend yields compared to those of publicly traded REITs. Non-traded REITs, on the other hand, regularly pay distributions in excess of their funds from operations, unlike publicly quoted REITs. They may do so by using money from offerings and borrowings. This approach, which is uncommon among publicly traded REITs, diminishes the value of the company’s shares and the cash available to buy more assets.
- Conflicts of Interest: Instead of using their own workers, non-traded REITs usually hire an outside manager. This may result in potential shareholder conflicts of interest. For example, the REIT may pay a hefty fee to the external manager based on the number of properties acquired and assets managed. Shareholders’ interests may not always be aligned with these fee incentives.
Why are REITs illiquid?
A non-traded REIT is a type of real estate investment strategy that aims to cut or eliminate taxes while generating real estate returns. A non-traded REIT is one that does not trade on a stock market and, as a result, can be quite illiquid for extended periods of time. Due to the limited secondary market, front-end costs can be as high as 15%, which is substantially greater than a traded REIT.
Any REIT owner expects to receive income from its real estate portfolio at some point, with rent being the most typical source of income. The types of properties that a non-traded REIT invests in early on may be undisclosed to investors, and the initial property acquisitions may be made through a blind pool, in which investors are unaware of the precise properties being added to the program’s portfolio.
A non-traded REIT’s early redemption can result in significant costs, lowering the total return. Non-traded REITs are subject to the same IRS rules as exchange-traded REITs, which include repaying at least 90% of taxable income to shareholders. For income distribution, investors prefer exchange-traded and non-traded REITs.
Non-traded REITs must be registered with the Securities and Exchange Commission even if they are not listed on any national securities exchanges (SEC). They must also file regulatory files on a regular basis. This entails filing a prospectus, as well as quarterly and yearly reports.
Because they are not traded on national exchanges and may not generate a stable income at first, non-traded REITs may stay illiquid for years after their start. Non-traded REITs’ periodic payouts to shareholders may be substantially financed by borrowed cash. The payment of such payments is not guaranteed and may exceed the REIT’s operating cash flow. The non-traded REIT’s board of directors has the authority to decide whether or not to make distributions and in what amount. When a non-traded REIT is first established, its initial payouts may be wholly funded by the cash invested by investors.
Many non-traded REITs have a built-in time limit that must be met before one of two actions can be implemented. The non-traded REIT must either become listed on a national exchange or liquidate at the conclusion of the time. When the program is liquidated, the value of the investment invested into such a REIT may have fallen or become worthless.
Are publicly traded REITs liquid?
A REIT qualifies as a “pass-through” entity if it meets these requirements. It does not pay any corporation income taxes as a result of this. As a result, it has more cash on hand to give out in dividends to investors.
A public stock exchange, such as the New York Stock Exchange or the NASDAQ, is where a traded REIT trades. REITs that are traded are extremely liquid. Every market day, tens or hundreds of thousands of shares of most significant REITs change hands.
In addition to liquidity, traded REITs are available to all types of investors. All you need is a brokerage account, preferably with a low-cost online broker, and the funds to purchase stocks.
In this category, there are two types of REITs: private REITs and public non-listed REITs (PNLRs).
Let’s start with private real estate investment trusts (REITs). These are distinct from public REITs in a number of ways.
For starters, they aren’t traded. That means they don’t sell shares on a public exchange for everyone to buy and sell. Private placements or direct solicitation of investors are used to make investments. The majority of private REITs have strict holding restrictions. You could be stuck with your stake for five years or longer with very limited or no options to sell it. If they do provide a redemption scheme, it’s not uncommon for sales to be at a discount to the REIT’s value.
Second, only accredited investors are allowed to invest in these types of REITs under the law. To get recognized, you must have a particular level of income and/or net worth. Huge institutional investors, like as pension funds and organizations with large endowments, are the primary target of private REITs.
Finally, private REITs are exempt from the Securities Exchange Commission’s registration requirements (SEC). They also don’t file financial reports as a result of this. Individual investors without the means or knowledge to comprehend and verify the eligibility of any given firm face significant risk as a result of the lack of oversight.
As a result, most investors don’t have access to private REITs, and even if they did, they wouldn’t be a good investment.
They don’t trade on stock exchanges, and their redemption restrictions are similar to those of private REITs. They are, nevertheless, registered with the Securities and Exchange Commission. As a result, they have increased oversight and financial disclosures that are publicly accessible and examined by an authorised accounting firm. State securities regulators are frequently involved in their oversight.
PNLRs are more accessible to most private investors due to increased regulatory scrutiny.
REITs, both traded and non-traded, can be good investments. However, due of the disparities in their trading and ownership restrictions, it’s critical to comprehend them.
Are private REITs liquid?
Because private REITs are not traded on stock exchanges, there is little to no publicly available or independent performance data on which investors can base their share price tracking. They are also exempt from filing annual financial statements with the Securities and Exchange Commission because they are not regulated by the federal body. Internal sources can only provide performance information to investors who have invested in private REITs.
Who can invest
Private REITs can issue securities to qualified institutional and accredited investors under the Securities Act of 1933. Institutional investors are businesses that invest on behalf of their members and are thought to have more specialized knowledge and thus the ability to defend themselves. Pension funds, hedge funds, insurance firms, endowment funds, and other institutions are among them.
Accredited investors, on the other hand, are those with a net worth of at least $1 million (excluding their primary property) or an annual income of more than $200,000 in the previous two years.
Minimum investment
Retail investors must make a minimum first investment of $10,000 to $100,000 in private REITs. The upfront cost needs, on the other hand, may differ from one organization to the next.
Liquidity
Because private REITs are not traded on public stock markets, they are not liquid. If an investor wishes to withdraw prior to a liquidation event, they must do so through redemption programs for shares, which are either limited, non-existent, or subject to change. They differ from public REITs, which are traded on a public security exchange and can be bought and sold with ease.
What are Publicly Traded Reits and How Do They Work?
The SEC regulates publicly traded REITs, and they are traded on the major stock markets. On a public securities exchange like the NYSE, individual investors can purchase and sell shares of publicly traded REITs. REITs that are publicly traded have the following characteristics:
Availability of information
Because publicly listed REITs are exchanged on public securities exchanges, performance data on the shares of a public REIT is readily available. The data is provided by both the REIT’s owner and trader, as well as independent businesses that actively monitor REITs.
REITs are also regulated by the Securities and Exchange Commission (SEC), which requires them to file audited financial accounts with the agency. The information is then available on the SEC website for interested investors.
Individual and institutional investors can buy and sell publicly traded REIT shares with a one-share minimum investment and the current share offering price. When purchasing through a broker, investors will be charged an upfront fee, which will be the same as any other public REIT.
A publicly traded REIT’s minimum investment is quite low. The initial investment, on the other hand, may differ from one company to the next.
Because REITs are traded on major stock exchanges, investors can readily acquire and sell shares of a publicly traded REIT at a reasonable price. In contrast to private REITs, which are less liquid, shareholders can easily enter and exit the market.
Summary of Private vs Publicly Traded REITs
The choice between a private REIT and a publicly traded REIT is based on the investor’s objectives and risk tolerance. A publicly traded REIT, for example, would be a better choice for an investor searching for a more liquid investment because they may purchase and sell its shares on the stock exchange with relative ease.
Private REITs, on the other hand, would be a better alternative if the investor’s purpose is to invest in a REIT that is not affected by stock market volatility.
Why are REITs a bad investment?
Real estate investment trusts (REITs) are not for everyone. This is the section for you if you’re wondering why REITs are a bad investment for you.
The major disadvantage of REITs is that they don’t provide much in the way of capital appreciation. This is because REITs must return 90 percent of their taxable income to investors, limiting their capacity to reinvest in properties to increase their value or acquire new holdings.
Another disadvantage is that REITs have very expensive management and transaction costs due to their structure.
REITs have also become increasingly connected with the larger stock market over time. As a result, one of the previous advantages has faded in value as your portfolio becomes more vulnerable to market fluctuations.
How do I cash out my REIT?
Thousands of people who invested billions of dollars in non-traded real estate investment trusts are now learning that getting their money out is a little more difficult.
According to the Wall Street Journal, several fund managers are limiting the amount of cash clients can withdraw from their funds, or sometimes refusing withdrawals altogether.
Small individual investors were drawn to non-traded REITs since many only only a few thousand dollars as a minimum investment, while providing access to a relatively stable real estate asset class.
According to the Journal, these funds have received $70 billion in investments since 2013. Blackstone and Starwood Capital Group, two of the industry’s biggest players, have developed massive non-traded REITs, and both are still enabling investors to withdraw from their funds.
The only method to get money out of a REIT is to redeem shares because they aren’t publicly traded. As the economy has been decimated by the coronavirus, resulting in millions of layoffs, many smaller investors are feeling the pinch and looking for alternative sources of income.
Meanwhile, fund managers are attempting to maintain some liquidity. Some claim they have no method of assessing the assets in the fund portfolios or the fund’s shares in the face of pandemic-induced economic uncertainty.
In late March, commercial REIT InPoint halted the sale of new shares and stopped paying dividends. According to the Journal, CEO Mitchell Sabshon stated that redeeming shares that value the REIT’s assets beyond their real value would be unfair.
Withdrawal request caps are built into some funds, and the rush to get money has triggered them. If share redemption requests surpass a specific threshold, alternative asset manager FS Investment places a limit on them.
According to FS Investment’s Matt Malone, this was “intended to safeguard all investors by striking a balance between providing liquidity and being forced to sell illiquid assets in a way that would be damaging to shareholders.”
Dennis Lynch is a writer.
Weak Growth
REITs that are publicly listed are required to pay out 90% of their profits in dividends to shareholders right away. This leaves little money to expand the portfolio by purchasing additional properties, which is what drives appreciation.
Private REITs are a good option if you enjoy the idea of REITs but want to get more than just dividends.
No Control Over Returns or Performance
Investors in direct real estate have a lot of control over their profits. They can identify properties with high cash flow, actively promote vacant rentals to renters, properly screen all applications, and use other property management best practices.
Investors in REITs, on the other hand, can only sell their shares if they are unhappy with the company’s performance. Some private REITs won’t even be able to do that, at least for the first several years.
Yield Taxed as Regular Income
Dividends are taxed at the (higher) regular income tax rate, despite the fact that profits on investments held longer than a year are taxed at the lower capital gains tax rate.
And because REITs provide a large portion of their returns in the form of dividends, investors may face a greater tax bill than they would with more appreciation-oriented assets.
Potential for High Risk and Fees
Just because an investment is regulated by the SEC does not mean it is low-risk. Before investing, do your homework and think about all aspects of the real estate market, including property valuations, interest rates, debt, geography, and changing tax regulations.
Fees should also be factored into the due diligence process. High management and transaction fees are charged by some REITs, resulting in smaller returns to shareholders. Those fees are frequently buried in the fine print of investment offerings, so be prepared to dig through the fine print to find out what they pay themselves for property management, acquisition fees, and so on.
Do REITs pay dividends?
A REIT is a security that invests directly in real estate and/or mortgages, comparable to a mutual fund. Mortgage REITs engage in portfolios of mortgages or mortgage-backed securities, whereas equity REITs invest mostly in commercial assets such as shopping malls, hotel hotels, and office buildings (MBSs). A hybrid REIT is a fund that invests in both. REIT shares are easy to buy and sell because they are traded on the open market.
All REITs have one thing in common: they pay dividends made up of rental income and capital gains. REITs must pay out at least 90% of their net earnings as dividends to shareholders in order to qualify as securities. REITs are given special tax treatment as a result of this; unlike a traditional business, they do not pay corporate taxes on the earnings they distribute. Regardless of whether the share price rises or falls, REITs must maintain a 90 percent payment.
Do REITs have tax advantages?
Understanding the tax implications of investing in a Real Estate Investment Trust (REIT) is one of the most important factors when adding commercial real estate investments to a well-balanced portfolio approach “When analyzing various options, REITs may be beneficial. Currently, Jamestown is offering Jamestown Invest 1, LLC (the) (the) (the) (the) (the) (the) (the) (the) “Fund”), which is available to accredited and non-accredited investors in the United States. The Fund is established as a REIT with the goal of acquiring and managing a portfolio of real estate investments in urban infill regions that are expected to grow. By the end of this article, you should be able to spot potential REIT tax benefits and better interpret your 1099-DIV form, as well as understand a few IRS rules relevant to REIT investments.
What is a REIT?
The United States Congress first introduced REITs in 1960. Until then, institutional investors were the only ones who could invest in commercial real estate. Most people lacked the financial means or resources to make important and diverse investments in the space. The REIT structure was designed by Congress to address this imbalance. Individual investors were able to pool assets and make major investments in commercial real estate by investing in a REIT.
You may have also heard that REITs are a time-consuming vehicle to manage, and this is correct! It is not, however, without justification. Congress has set various restrictions on the structure and operation of REITs in order to ensure that they meet their legislative goals. The REIT must maintain certain levels of investment in real estate assets and earn particular levels of income from real estate and other passive vehicles in order to be considered a passive real estate investor. There are special shareholder criteria and constraints on the concentration of ownership of REIT shares to ensure that money are pooled by individual investors. REITs that meet these criteria receive preferential tax treatment (discussed in more detail below).
How Are Realized Returns Determined?
Before going into some of the tax advantages of investing in a REIT fund, it’s crucial to understand how commercial real estate trusts create profits for investors. Operating distributions and capital gain distributions are the two components of real estate realized returns.
- Investors receive operating distributions (usually monthly or quarterly) from the cash flow generated by the fund’s underlying real estate investments. This is usually achieved by net rental income or portfolio income from the REIT, such as interest and dividends.
- The capital gain from the sale of real estate within the REIT is the second component of realized returns potential.
How Are Realized Returns Categorized?
A REIT must transfer the bulk of its taxable income to its shareholders in order to maintain its beneficial tax status. REIT distributions are classified into one of the following types. There is a different tax treatment for each category.
- Capital Gains — depending on whether the investment or its underlying property is kept for less than or more than 12 months, capital gains are taxed at a short-term or long-term capital gain rate.
If you recall from our post on How to Invest in Real Estate with a Self-Directed IRA, if you own a REIT in a tax-deferred account like a regular IRA, you only pay taxes on the money when you remove it.
What Are the Potential Tax Benefits of Investing in a REIT?
REITs are eligible for special tax treatment if they meet the IRS’s standards. Eligible REIT structures, unlike other U.S. corporations, are not subject to double taxation. Dividends provided to shareholders help REITs avoid paying corporate income tax. Shareholders may then benefit from preferential US tax rates on REIT dividend distributions.
The Tax Cuts and Jobs Act (TCJA), which was signed into law in 2017, made REIT investing even more tax-efficient. Many taxpayers are eligible for a tax deduction of up to 20% for Qualified Business Income under the TCJA, subject to specified income criteria. Ordinary REIT dividends, interestingly, qualify as Business Income for this reason, and REIT dividends aren’t subject to the income thresholds, thus REIT investors can take advantage of this provision regardless of their income!
The qualified business income deduction is equal to the lesser of (1) 20% of combined qualified business income or (2) 20% of taxable income minus the taxpayer’s net capital gain amount (if any).
The hypothetical after-tax return shown below is based on a $10,000 investment with a 7% yearly dividend yield. We’ll assume a single tax filer who has no capital gains and is in the highest federal marginal tax rate of 37 percent in 2020.
Will I Receive a Schedule K-1 or Form 1099-DIV?
Investors frequently inquire about whether they will receive a 1099 or a K-1 at the start of the year. While a Sponsor’s Investor Relations or Tax Team can provide this information, there are some general standards to be aware of before investing.
A REIT, brokerage, bank, mutual fund, or real estate fund issues Form 1099-DIV to the Internal Revenue Service. Persons who have received dividends or other distributions of $10 or more in money or other property will get Form 1099-DIV. Dividend income is taxed in the state(s) where the person resides, regardless of the location of the property.
Schedule K-1 is an annual tax form issued by the Internal Revenue Service for a partnership investment. Schedule K-1 is used to report each partner’s portion of the partnership’s profit, loss, deductions, and credits. Real estate partnership income may be taxed in the state(s) where the property is located. A Schedule K-1 is identical to a Form 1099 in terms of tax reporting.
Understanding your IRS Form 1099-DIV
If you invest directly in a REIT, you will receive a 1099-DIV from the REIT. You’ll find that numerous boxes on your Form 1099-DIV have already been filled in. Some of the reporting boxes and their ramifications were recently detailed in an article released by TurboTax, a market leader in tax software for preparing US tax returns.
- The percentage of box 1a that is considered qualified dividends is reported in box 1b.
- If you get a capital gain distribution from your investment, you must record it in box 2a.
- If any state or federal taxes were withheld from your dividends, report them in boxes 4 and 14 for federal withholding and state withholding, respectively.
REITs that comply with the law are exempt from paying corporate taxes. Ordinary and capital gain dividend income are taxed at the REIT shareholders’ respective tax rates. Ordinary dividends paid by REITs can be deducted up to 20% before income tax is calculated.
Built-in diversification without the hassle of several state income tax forms is an advantage of investing in a fund with exposure to multiple properties. In comparison to investing in numerous individual properties via partnerships, investors will only pay state taxes on their dividends and capital gains in their individual state(s) of residence.
While many people are aware with publicly traded REITs that offer the tax benefits we’ve discussed, combining some of these benefits with non-correlative private real estate may be a viable option for investors looking for a more diversified portfolio. Alternative investments have been a part of many high-net-worth individuals’ and institutions’ portfolios for decades, but they are still not a portfolio staple for many people.
How are REITs taxed?
Dividend payments are assigned to ordinary income, capital gains, and return of capital for tax reasons for REITs, each of which may be taxed at a different rate. Early in the year, all public firms, including REITs, must furnish shareholders with information indicating how the prior year’s dividends should be allocated for tax purposes. The Industry Data section contains a historical record of the allocation of REIT distributions between regular income, return of capital, and capital gains.
The majority of REIT dividends are taxed as ordinary income up to a maximum rate of 37% (returning to 39.6% in 2026), plus a 3.8 percent surtax on investment income. Through December 31, 2025, taxpayers can deduct 20% of their combined qualifying business income, which includes Qualified REIT Dividends. When the 20% deduction is taken into account, the highest effective tax rate on Qualified REIT Dividends is normally 29.6%.
REIT dividends, on the other hand, will be taxed at a lower rate in the following situations:
- When a REIT makes a capital gains distribution (tax rate of up to 20% plus a 3.8 percent surtax) or a return of capital dividend (tax rate of up to 20% plus a 3.8 percent surtax);
- When a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from
- When allowed, a REIT pays corporation taxes and keeps the profits (20 percent maximum tax rate, plus the 3.8 percent surtax).
Furthermore, the maximum capital gains rate of 20% (plus the 3.8 percent surtax) applies to the sale of REIT stock in general.
The withholding tax rate on REIT ordinary dividends paid to non-US investors is depicted in this graph.
How are REITs traded?
The majority of REITs in the United States trade on the New York Stock Exchange (NYSE) or the Nasdaq Stock Market (NASDAQ). A FINRA-registered broker can help investors purchase shares in a publicly traded REIT. Investors can purchase REIT common stock, preferred stock, or debt securities in the same way they can other publicly listed assets.
