Education

Real Estate Investment Trusts: Everything You Need to Know to Get Started

By Nat Kunes January 14 2020 5 min read

Are you thinking about starting a real estate investment trust? Before you go all in, it’s important to learn the basics of how a real estate investment trust works, how the money is distributed, and who is involved. Read on to get all the information you need, so you can start your own trust with confidence.

What is a Real Estate Investment Trust?

A real estate investment trust (REIT) is a company that allows its members to invest in real estate by pooling their funds. It’s similar to a mutual fund for real estate and can earn income for investors in a variety of ways. Some REITs buy properties and rent them to tenants, while others develop properties or offer mortgages to home buyers. REITs differ from other investments in many ways, so you’ll need to weigh the pros and cons carefully before you invest.

How Does a REIT Make Money?

Simply put, a REIT’s investment goal is to generate income distribution and long-term appreciation. You invest in a real estate investment trust through a broker, just as you would in stocks or mutual funds.

Investors, also known as unit holders, raise the money for an REIT through an initial public offering (IPO), which a professional REIT manager uses to purchase an initial pool of real estate properties. These properties include serviced apartments, hotels, shopping malls, and offices that generate income for the unit holders, generally in the form of rent, leasing, or property sales. This income flows back to the unit holders as income distributions, which are similar to the dividends of a stock or mutual fund.

Most REITs have a variety of expenses, such as the fees for the REIT managers, property managers, and trustees, which are deducted before the distributions are made to the unit holders. In addition, REITs may also be subject to taxes based on the jurisdiction of the properties. Generally, a REIT’s financial statement contains further details that are specific to its’ structure.

How is the Money From a REIT Distributed?

When it comes to starting a REIT, knowing how the money is distributed is key. All-in-all the process is actually fairly simple: A REIT’s income is sent directly to the REIT holder on a regular basis, next the expenses are deducted, and the profits are distributed among the unit holders as a percentage of the shares owned by each unit holder. As a rule of thumb, a REIT should distribute 90% of its taxable income to maintain its’ status, excluding foreclosure income and capital gains. In addition, dividends generally apply to the tax year in which they’re actually paid. Sometimes certain events can cause a REIT to fail meet its distribution requirements, such as when the REIT receives prepaid rent at the end of the tax year.

Who is Involved in a REIT?

Multiple parties are typically involved in a REIT. Here’s a breakdown of their roles and responsibilities:

Trustee: The trustee is responsible for holding the REIT’s assets on behalf of the unit holders. Additional responsibilities include ensuring the REIT complies with applicable laws such as those protecting the rights of unit holders. Generally speaking, a trustee’s specific duties are defined in the trust deed.

REIT Manager: The REIT manager develops and executes the REIT according to its investment strategy, especially the acquisition and divestment of properties. For an externally-managed REIT, the manager receives a fee for these services that includes a base fee and performance fee. In addition, the manager may also receive fees for acquisition and divestment.

Property Manager: The property manager manages the REIT’s properties for a fee from the REIT’s assets. Specific responsibilities include renting out the properties to maximize income, and promoting the property and maintaining it. Usually, the property manager is appointed by the REIT manager.

Sponsor: This isn’t always the case, but some REITs have a sponsor who sources the properties in the initial portfolio. Sometimes the sponsor may also continue to provide assets for the REIT after it’s sourced. Most often a sponsor owns shares in the REIT.

What are the Benefits of REITs?

A REIT’s affordability is one of its greatest benefits. Individual investors who might not otherwise be able to directly invest in a major property, such as an office building or shopping mall, are able do so through an REIT.

The distributions that investors receive from an REIT are exempt from income taxes. The REIT itself is also generally transparent to taxes with respect to IRAs, provided it distributes at least 90% of its taxable income each year.

REITs are also primarily liquid assets, as it’s easier to buy and sell shares in a REIT than it is to buy and sell properties. As a result, they’re often listed on stock exchanges, which allows investors to buy and trade shares on trading days.

What are the Risks of REITs?

While the pros generally outweigh the cons of REITs, it’s good to know the risks. One risk is that REITs distribute their profits to unit holders as they accrue, which means they could fail to make mortgage payments if they don’t generate a profit in a timely manner. Furthermore, a REIT might not be able to secure refinancing, which could require the manager to sell off some of its properties.

In addition, the distributions from a REIT don’t always provide steady income, since they’re subject to fluctuation. For example, distributions could drop if a lease must be renewed at a lower rate to maintain a desired occupancy rate. Luckily, some REITs include clauses, like lock-in rates in their leases, to minimize these types of distribution fluctuations.

Ways Technology Can Help You Start a Real Estate Investment Trust

Now that you know the basics of how a real estate investment trust works and who’s involved, you can learn more about the technologies that can help you get started. Modern investment management software can give you the tools you need to impress your investors, track distributions, and manage your real estate investment trust effectively. Here are some ways AppFolio Investment Management can simplify the REIT process:

  • Consolidates Your Data:
    With everything in a single, shareable document, you can easily distribute report packets and performance metrics to investors.
  • Enhances Communication:
    Modern communication tools built in the software allow you to email investors individually by investment or create custom groupings.
  • Impresses Investors:
    A personalized, self-service portal keeps investors updated, informed, and engaged.