Investing in a REIT

In the early 2000s, many investors jumped onto the rollercoaster of excitement known as the stock market. However, once the stock market proved too volatile and inconsistent with forecasts, investors became less confident and looked elsewhere to invest their hard-earned money. As our market evolves, millennials in particular grow more concerned about the future of their financial stability. Unfortunately, not everyone has the time or the millions of dollars it takes to operate a large corporation or commercial property. In today’s market, investors looking for stable growth and appreciation in value may want to consider a real estate investment trust (REIT).

REITs can be broken down into two main categories—equity and mortgage—both of which can be traded on a national stock exchange. An equity REIT generates income via rent collection from tenants, appreciation of the property, and from the sale of a long-term owned property. On the other hand, a mortgage REIT derives income from the interest earned on a mortgage loan or mortgage-backed security of a commercial or residential property. REITs can be further classified based on their qualifications and requirements.

An REIT allows a wide range of investors to take part in the ownership of a real estate venture with limited investment and without the hassle of operation or management. Instead, a real estate investment trust will manage the property for you. REIT companies carefully select the commercial properties to include in their portfolios to ensure they are well-diversified.

Investing in an REIT not only alleviates the stress of managing income-producing property, but also provides many other financial benefits:

1) REITs add diversity to your personal portfolio and tend to mitigate overall risk.

2) REITs are subject to the same operating rule as other public companies and must divulge the required financial reports by the SEC.

3) Equity REITs have little correlation to returns on the stock market over a long-term period.

4) The annual total return for an REIT proves more financially successful and stable over the long term. According to the National Association of REITs (NAREIT®), the yield on a 15-year investment for an REIT outperformed S&P 500 by 8.05 percent. With an 18-year trend cycle that is studied correctly, unforeseen, drastic changes are less likely to occur.

5) Tax treatment is simple. REITs do not pay taxes at the corporate level; however, these taxes are passed to the shareholders. As 90 percent of taxable income for the company must be distributed to shareholders as dividends, REIT companies are usually among the highest in terms of paid dividends.

Homeowners in Silicon Valley have watched real estate prices skyrocket in the past few decades, but are unable to access this resource of wealth due to the illiquidity of their real property. Although some consider selling their property to be relieved of the hassle of ownership, they are more reluctant to take on the crippling capital gains tax that comes with it. Thus, investors have been exploring a special kind of REIT which ultimately satisfies this problem. With careful planning, the seller of highly appreciated investment property can exchange the investment property for operating partnership (OP) units in an umbrella partnership REIT (UPREIT) of equal value, resulting in the deferral of capital gains. This is accomplished by utilizing a 1031 exchange (see Michael Repka’s “Capital Gains and 1031 Exchanges” in this newsletter). Much like more conventional REITs, a UPREIT allows property owners to expand their interests from a single property to a diversified portfolio of carefully selected properties. This may be of particular benefit to sellers who do not want to actively manage a single investment property.

With this type of transaction, there are two main risks. Upon completing this transaction, the UPREIT has control over the relinquished property and, if sold, may “trigger the recognition of the investor’s deferred capital gain and any depreciation recapture.” Oftentimes, UPREITs may agree to “not trigger any taxable gain for a specified number of years.” Also, once the investor sells the REIT shares back to the firm, the investor’s deferred capital gains taxes and depreciation recapture will be recognized.* Fortunately, shares in a UPREIT have its benefits around this in estate-planning. If OP units are held onto for life and have been included in a taxable estate, the heirs of the estate may sell the shares back to the firm for cash, without triggering the capital gains tax.

The risks of investing in an REIT pales in comparison to the daily risk involved with investing in the stock market. REITs, with less volatility than the stock market, are growing in popularity for investors who are looking to diversify their portfolios, increase the liquidity of their assets, and receive steady dividends. To find out more about REITs, visit nareit.

*“Investing in UPREITs as 1031 Exchange Replacement Property Solution.” Investing in UPREITs as 1031 Exchange Replacement Property Solution. Web. 12 Mar. 2016. < upREIT_1031_721.aspx>.