4. What are the requirements to become a REIT?
A corporation must make a REIT election by filing an income tax return on Form 1120-REIT in order to qualify as a REIT. The REIT does not make its election until after the end of its first year (or part-year) as a REIT, because this form is not due until March. Nonetheless, if it wants to qualify as a REIT for that year, it must pass all of the REIT standards (excluding the 100 Shareholder Test and the 5/50 Test, which must be passed starting with the REIT’s second taxable year).
In addition, the REIT is required to send annual letters to its shareholders inquiring about beneficial ownership of its shares. If a REIT fails to mail these letters on schedule, it will face severe fines.
Create a partnership agreement that specifies each partner’s percentage ownership, financial contributions, and responsibilities in the REIT. Most REITs start out as management businesses since they need a minimum of 100 investors after their first year of operation to qualify as a REIT. A partnership agreement will aid you and your partners in avoiding future costly mistakes and arguments.
Can you have a private REIT?
Private REITs are real estate funds or companies that are not required to register with the Securities and Exchange Commission (SEC) and whose shares do not trade on national stock markets. Institutional investors are the only ones who can buy private REITs.
How do you firm a REIT?
- Rents from real estate, interest on mortgages financing real estate, or sales of real estate must account for at least 75% of gross income.
- Each year, pay at least 90% of its taxable profits to shareholders in the form of dividends.
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.
Can a REIT own another REIT?
To ensure that the majority of a REIT’s income and assets come from real estate sources, it must pass two yearly income tests and a number of quarterly asset tests.
Real estate-related income, such as rentals from real property and interest on obligations secured by mortgages on real property, must account for at least 75% of the REIT’s annual gross income. An additional 20% of the REIT’s gross revenue must come from the above-mentioned sources or from non-real estate sources such as dividends and interest (like bank deposit interest). Non-qualifying sources of revenue, such as service fees or a non-real estate business, cannot account for more than 5% of a REIT’s income.
At least 75 percent of a REIT’s assets must be real estate assets, such as real property or loans secured by real property, on a quarterly basis. A REIT cannot own more than 10% of the voting securities of any corporation other than another REIT, a taxable REIT subsidiary (TRS), or a qualified REIT subsidiary, directly or indirectly (QRS). A REIT cannot own stock in a corporation (other than a REIT, TRS, or QRS) in which the stock’s worth exceeds 5% of the REIT’s assets. Finally, the stock of all of a REIT’s TRSs cannot account for more than 20% of the value of the REIT’s assets.
How many private REITs are there?
How many private REITs exist in the United States? There are around 1,100 REITs — both public and private — in existence at this time. Because they are not registered with the SEC, almost 800 of them are presumed to be private REITs.
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 are private REITs taxed?
Due to their flexibility, cheap cost, and tax efficiency, limited partnerships and limited liability companies are often the favored entities for private real estate investment. Private REITs, on the other hand, may deliver much better after-tax earnings in the appropriate circumstances, despite their higher cost and complexity.
This article gives a quick rundown of REIT criteria and how private REITs might be used as potentially tax-advantageous structures for private investment funds. It examines important requirements, as well as numerous tax planning options, particularly for foreign and tax-exempt investors, as well as diligence and compliance responsibilities.
The term “REIT” stands for “real estate investment trust.” REITs were designed to allow for tax-efficient public real estate investment, but they’ve also become popular as private entities. REITs that are not publicly listed are known as private REITs.
A company can become a REIT by making a tax election and meeting certain criteria. These include the fact that its assets are mostly real estate, that its income is mostly real estate, and that it passes ownership, operational, and other standards.
Because, unlike corporations in general, REITs can deduct dividends paid when calculating taxable income, they are partial conduits. As a result, if a REIT’s dividends paid are at least equal to its taxable revenue, it owes no federal income tax. Dividends received from a REIT are taxed to the REIT’s shareholders. A REIT’s dividends may be taxed at long-term capital gain rates to the extent that long-term capital gains are distributed; the remainder of any dividends is taxed as ordinary income.
The regulations, potential tax benefits, difficulties, and hazards connected with private REITs as vehicles for private investment funds are outlined below.
A variety of tests and other requirements must be met in order to qualify as a REIT. The fact that REITs are designed to be passive real estate investment vehicles is reflected in a few important conditions.
- Rents on real estate, gain from the sale of real estate, and interest on real estate-secured loans account for at least 75% of gross revenue. There are several exceptions and restrictions that must be considered on a case-by-case basis. Related party rents, “percentage” rents, and interest collected on debt obtained at a discount, for example, may not qualify as real estate income (in whole or in part).
- Real estate income or certain types of passive income, such as dividends and interest, account for at least 95 percent of total revenue.
Asset evaluations In most cases, the REIT asset tests must be passed at the end of each calendar quarter.
- “Real estate assets,” cash and cash equivalents, and government securities account for at least 75% of the REIT’s assets. Interests in real property (e.g., fee ownership, leaseholds, and purchase options in real property), loans secured by real property, and interests in other REITs are all examples of real estate assets for this purpose. There are several exceptions and unique constraints, similar to the gross income requirements, that necessitate case-by-case scrutiny. Debt purchased at a bargain, for example, may be considered just partially a real estate asset.
- Non-real estate assets meet diversification requirements and other restrictions.
Minimum distributions per year. Each year, the REIT pays dividends equivalent to at least 90% of its taxable income. These dividends can be paid in cash or other forms of property, or they can be paid through a consent procedure. Consent dividends do not require a physical payout, although they are liable to withholding taxes for foreign REIT shareholders. Dividends received after the end of the fiscal year are usually subject to a 4% excise tax. Net capital gain and a limited amount of certain noncash income (e.g., a limited amount of original issue discount (OID)) are exempt from the distribution requirement. The REIT, on the other hand, is subject to income tax to the extent that it retains any taxable income.
It’s not a tightly held secret. During the last half of the REIT’s taxable year, no more than five people (directly or indirectly) can own more than 50% of the REIT’s stock. Private foundations, certain trusts, and certain pension and similar plans are recognized as “individuals” for this purpose. This criterion necessitates due diligence, but it is rarely a problem for private investment firms.
Shares can be easily transferred.
If the REIT is employed as a vehicle by a private investment fund, this criterion is usually not an issue (e.g., if the REIT is a subsidiary of the fund). However, it generally inhibits the fund from becoming a REIT because private investment funds normally do not allow investors to transfer fund interests other than through redemption.
Other conditions must be met. The following needs are often non-essential.
- Election to pay taxes. This is accomplished by timely filing a Form 1120-REIT income tax return for the first year in which REIT status is requested.
- A minimum number of stockholders is required. Have at least 100 direct stockholders. Extra shareholders for a private REIT might be gained through a limited issue of preferred shares. These preferred shares are usually non-voting and only have a right to a return of capital plus a fixed annual coupon.
- Whether it’s a corporation, trust, or association, it’s a legal entity. This requirement is out of date. Trusts, corporations, limited partnerships, limited liability companies, and other forms of legal entities may qualify as REITs under existing entity classification laws.
- Trustees or directors are in charge of the organization. This need is usually not a problem, but if the REIT is structured as a limited partnership, it may necessitate extra attention to the REIT’s constitutive documents and management structure.
What assets can a REIT own?
A real estate investment trust (REIT) is a corporation that owns and operates income-producing real estate or real estate-related assets. Office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans are examples of income-producing real estate assets controlled by REITs.
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.
How do REITs make money?
REITs, like any other business, require capital. An IPO (initial public offering) is how a publicly traded REIT (real estate investment trust) accomplishes this. This is similar to selling any other stock to the general public, who are investing in the company’s income-producing real estate. People who purchase initial public offerings (IPOs) are investing in real estate that is managed similarly to a stock portfolio. These outside cash sources allow the REIT to acquire, develop, and manage real estate in order to generate profits. REITs generate income, and shareholders must get 90 percent of that taxable income on a regular basis. REITs create money by renting, leasing, or selling the assets they purchase. The shareholders elect a board of directors, which is in charge of selecting investments and recruiting a team to oversee them on a daily basis.
FFO stands for funds from operations, which is how most REIT earnings are calculated. FFO is defined by the National Association of Real Estate Investment Trusts (NAREIT) as the net income from rent and/or sales of properties after deducting administrative and financing costs. The NAREIT’s net income computations follow GAAP (generally recognized accounting rules). The issue is that depreciation of assets is presumed to be a predictable given in GAAP calculations, which skews the true measure of a REIT’s revenue in a negative direction because real estate, which is what REITs deal in, retains or even improves in value over time. As a result, depreciation is not included in FFO’s net income.
