A REIT is a corporation that invests in real estate directly, either through properties or mortgages, and is sold as a security. REITs typically raise $1 to $2 billion in capital and purchase a portfolio of properties over a period of several years with the intention of producing rental income. A REIT must abide by specific rules and restrictions so that it is not required to pay corporate income taxes. Specifically, it must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends. As a result, all dividend distributions made by the REIT to its investors are taxed only at the investor level, thereby avoiding any double taxation.
REITs can either be offered as private placement investments to accredited investors or publicly traded. Fortitude offers private placement investments, which should be considered illiquid investments. Typically, the goal of these REITs is to be offered publicly through an initial public offering or to be purchased entirely by a larger REIT, but these outcomes cannot be predicted with certainty and depend on the performance of the particular properties in the REIT as well as trends in the real estate market as a whole.
Types of REITs
- Equity REITs invest in and own properties and are measured by the equity or value of their real estate assets. Their revenues come principally from their properties’ rents.
- Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.
- Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.
Risks of Real Estate Investment Trusts
Because they do not trade on a stock exchange, non-traded REITs involve special risks, including but not limited to:
- Lack of Liquidity
Non-traded REITs are illiquid investments. They generally cannot be sold readily on the open market. If you need to sell an asset to raise money quickly, you may not be able to do so with shares of a non-traded REIT.
- Share Value Transparency
While the market price of a publicly traded REIT is readily accessible, it can be difficult to determine the value of a share of a non-traded REIT. Non-traded REITs typically do not provide an estimate of their value per share until 18 months after their offering closes. As a result, you may be unable to assess the value of your non-traded REIT investment and its volatility for a significant time.
- Distributions May Be Paid from Offering Proceeds and Borrowings
Investors may be attracted to non-traded REITs by their relatively high dividend yields compared to those of publicly traded REITs. Unlike publicly traded REITs, however, non-traded REITs frequently pay distributions in excess of their funds from operations. To do so, they may use offering proceeds and borrowings. This practice, which is typically not used by publicly traded REITs, reduces the value of the shares and the cash available to the company to purchase additional assets.
- Conflicts of Interest
Non-traded REITs typically have an external manager instead of their own employees. This can lead to potential conflicts of interests with shareholders. For example, the REIT may pay the external manager significant fees based on the amount of property acquisitions and assets under management. These fee incentives may not necessarily align with the interests of shareholders.