Learning How REITs Can Build Your Real Estate Investment

Portfolio

Summary About Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) are used by investors for investing in real estate without the worry
of vetting and purchasing individual properties. REITs provide investors with access to a professionally
managed portfolio that consists of real estate assets. REITs were first created more than 50 years ago
and defined specifically in subchapter M, Chapter 1 of the Internal Revenue Code of 1986. In an
infographic provided by the National Association of Real Estate Investment Trusts (NAREIT), a
Washington, D.C. based trade group:

REITs own real estate holdings worth $1 trillion;
50 million American investors invest in REITs (primarily through their 401(k)s);
There are near 300 REITs registered with the U.S. Securities and Exchange Commission;
The 160 REITs that are listed on the New York Stock Exchange have a market capitalization of
$650 million; and,
REITs own $88.7 billion of commercial property in the State of California while the most
commercial property owned by REITs is in the State of Texas (3,784).

Companies such as Apartment Investment and Management Co. (NYSE:AIV), Realty Income Corp
(NYSE:O) and Annaly Capital Management, Inc. (NYSE:NLY) are examples of publicly traded REITs that
investors can look to for information on how REITs work and the types of investments these companies
make, as well as how they benefit and profit investors.

What Are Real Estate Investment Trusts?

REITs are a type of investment trust that is similar to what are known as a "closed-end investment
companies." You are familiar with these types of investments as exchange traded funds (ETFs) and unit
investment trusts (UITs). A REIT invests funds it acquires from investors in property (real estate), any
mortgages and mortgage interests on property and may also invest in other REITs.

There are generally three types of REITs that investors can choose to invest in: equity REITs, mortgage
REITs and hybrid REITs (investing in equity or property ownership and mortgage interests). Equity REITs
invest in properties, deriving their income through rents; mortgage REITs make available mortgage loans
(and may invest in mortgage-backed securities like those issued by Fannie Mae or Freddie Mac) and
earn income through interest. A hybrid REIT, as its name implies, invests in both properties for rental
income and makes mortgage loans available.



How Do REITs Operate?

REITs are organized as investment companies, subject to the registration rules of the Investment
Company Act of 1940, except mortgage REITs are not subject to registration requirement of the ICA '40
as they engage in mortgage banking. All REITs however operate in a similar manner pursuant to
prevailing federal securities laws as well as the laws of the state in which the REIT is domiciled.

A REIT begins life by creating
a portfolio (based on the
type of REIT) and selling
shares of beneficial interest
to investors through an
offering. This of course after
the trust has been
incorporated as a
corporation for federal tax
purposes. REITs are formed
when they meet two
ownership rules by its
second operating year: (1)
at least 100 unique
shareholders; and, (2) no more than 5 (or fewer individuals) can own more than 50 percent of the value
of the REITs shares (known as the "5/50" rule). REITs must also invest 75 percent or more of assets in
real estate and cash. Shares of REITs must be transferrable, which is why they trade on a public
exchange, and derive by rule at least 75 percent of its gross income from real estate related sources (i.e.
rents and mortgage interests).

How Do Investors Profit from REITs?

Investors who purchase shares of REIT, which trade publicly, must receive at least 90 percent of the
REITs taxable income, distributed on an annual basis. This income is derived by the investment activities
of the REIT, depending on the type of investment trust that has been created (i.e. equity, mortgage, and
hybrid).

What Are the Advantages to REIT Investing?

One of the biggest advantages to investing in REITs is the passive nature of the investment. The
investments that make up the trust are selected by professional managers who understand the market
and have experience selecting the best investments for the portfolio. This removes the worry and fear
that an investor may have over evaluating the quality of an investment and choosing which one to
include in a portfolio of real estate holdings. Another advantage is that of tax reporting for the REIT. As
Source: Retrieved from http://www.mbaskool.com/images/stories/art_2012/reit_overview.jpg, October 4,
2013.
an investor, gains and losses reported in any given tax year are provided with a 1099-DIV, which
provides information on dividends distributed by the REIT as capital gains, return of principal and
ordinary income. The 1099-DIV is attached to the Form 1120-REIT that is attached to a taxpayer's 1040
long form.

Conclusion

Investors looking for a simple and easy way to invest in real estate should consider how REITs can
provide a benefit to a portfolio. Referencing again the infographic produced by NAREIT, $29 billion in
dividends were paid by REITs in 2012. This may give you pause to look at REITs for your next investment
opportunity.