A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing properties. By law, 90% of a REIT’s profits must be distributed as dividends to shareholders.

Here, we take a look at REITs, their characteristics, how to evaluate a REIT, and ways to invest in REITs, such as through real estate crowdfunding platfor♑ms⛎.

What Qualifies As a REIT?

Most REITs lease space and collect rents, then 澳洲幸运5开奖号码历史查询:distribute that income as dividends to shareholders. Mortgage REITs (also called mREITs) don’t own real estate; instead, they finance real estate. These REITs earn income from the interest on their investments, which include mortgages, 澳洲幸运5开奖号码历史查询:mortgage-backed securities (MBSs), and other related assets.

To , a companyꦬ must comply with certain Internal Revenue Code (IRC) provisions. Specifically, a company must meet the following requirements to qualify as a REIT:

• Invest at least 75% of total assets in real estate or cash
• Earn at least 75% of gross income from rents, interest on mortgages that finance real property, or real estate sales
• Pay a minimum of 90% of taxable income in the form of shareholder dividends each year
• Be an entity that’s taxable as a corporation
• Be managed by a board of directors or trustees
• Have shares that are fully transferable
• Have at least 100 shareholders after its first year of existence 
• Have no more than 50% of its shares held by five or fewer individuals
•  Derive at least 95% of its gross income from such real estate sources and dividends or interest from any source
• Have no more than 25% of its assets consist of non-qualifying securities or stock in taxable REIT subsidiaries

By having REIT status, a company avoids most or all of the corporate income tax. A regular corporation makes a profit and pays taxes on its entire profit, then decides how to allocate its after-tax profits between dividends and reinvestment. A REIT simply distributes all or almost all of its profits and only pays taxes on anything it doesn't distribute.

Types of REITs

There are a number of 澳洲幸运5开奖号码历史查询:different types of REITs. Equity REITs tend to specialize in 澳洲幸运5开奖号码历史查询:owning certain building types such as apartments, regional malls, office buildings, or lodging/resort facilities. Some are diversified and some defy classification—for exampl🗹e, a REIT that inv🐻ests only in golf courses.

The other main type of REIT is a mortgage REIT. These REITs make loans secured by real estate, but they do not generally own or operate real estate. Mortgage REITs require special analysis. They are finance companies that use several hedging instruments to manage their interest raꦗte exposure.

While a handful of hybrid REITs run real estate operations and transact in mortgage loans, most REITs are the equity type—the REIꦛTs that focus on the “hard asset” business of real estate operations. When you read about REITs, you are usually reading about equity REITs. As such, we’ll focus our analysis on equity REITs.

How to Analyze REITs

REITs are dividend-paying stocks that focus on real estate. If you seek🍸 inco𝓰me, you would consider them along with high-yield bond funds and dividend-paying stocks. As dividend-paying stocks, REITs are analyzed much like other stocks. However, there are some big differences due to the accounting treatment of property.

Let’s illustrate this with a simplified example. Suppose that a REIT buys a building for $1 million. Accounting rules require our REIT to charge depreciation against the asset. Let’s assume that we spread the depreciation over 20 years in a straight line. Each year, we deduct $50,000 in depreciation expense ($50,000 per year × 20 years = $1 million).

Let’s look at the simplified balance sheet and income statement above. In year 10, our balance sheet carries the value of the building at $500,000 (i.e., the 澳洲幸运5开奖号码历史查询:book value), which is the original cost of $1 million minus $500,000 accumulated depreciation (10 years × $50,000 pe𝓰r year). Our income 🍷statement deducts $190,000 of expenses from $200,000 in revenues, but $50,000 of the expense is a depreciation charge.

FFO

However, our REIT doesn’t actually spend this money in year 10—depreciation is a 澳洲幸运5开奖号码历史查询:non-cash charge. Therefore, we add back the depreciation charge to the net income to produce 澳洲幸运5开奖号码历史查询:funds from operations (FFO). The idea is that depreciation u♉nfairly reduces our net income because our building probably didn’t lose half its value over the last 10 years. FFO fixes t🔯his presumed distortion by excluding the depreciation charge. FFO includes a few other adjustments, too.

AFFO

We should note that FFO gets closer to cash flow than net income, but it does not capture cash flow. Mainly, notice in the example above that we never counted the $1 million spent to acquire the building (the capital expenditure). A more accurate analysis would incorporate capital expenditures. Counting capital expenditures gives a figure known as 澳洲幸运5开奖号码历史查询:adju𒁏sted funds f🦩rom operations (AFFO).

Net Asset Value

Our hypothetical balance sheet can help us understand the other common REIT metric: 澳洲幸运5开奖号码历史查询:net asset value (NAV). In year 10, the book value of our building was only $500,000 because half of thꦍe original cost was depreciated. So, book value and related ratios like price-to-book—often dubious in regard to general equities analysis—are pretty much useless for REITs. NAV attempts to replace the book value of a property with a better estimate of market value.

Calculating NAV requires a somewhat subjective appraisal of the REIT’s holdings. In the above example, we see the building generates $100,000 in operating income ($200,000 in revenues minus $100,000 in operating expenses). One method would be to capitalize on the operating income based on a market rate. If we think that the market’s present 澳洲幸运5开奖号码历史查询:capitalization rate (cap rate) for this type of building is 8%, then our estimate of the building’s value becomes $1.25 million ($100,000 in ope💯rating income ÷ 8% cap rate🍷 = $1,250,000).

This market value estimate 澳洲幸运5开奖号码历史查询:replaces the book value of the💎 building. We then would dedu🀅ct the mortgage debt (not shown) to get NAV. Assets minus debt will equal equity, where the “net” in NAV means net of debt. The final step is to divide NAV into common shares to get NAV per share, which is an estimate of intrinsic value. In theory, the quoted share price should not stray too far from the NAV per share.

Top-Down vs. Bottom-Up Analysis

When picking stocks, you sometimes hear of top-down versus 澳洲幸运5开奖号码历史查询:bottom-up analysis. Top-down starts with an economic perspective and bets on themes or sectors (for example, an aging demographic may favor drug companies). 🌟Bottom-up focuses on the fundamentals of specific companies. REIT stocks clearly require both top-down and bottom-up analysis.

From a top-down perspective, REITs can be affected by anything that impacts the supply of, and♍ demand for, property. Population and job growth tend to be favorable for all REIT types. Interest rates are, in brief, a mixed bag.

A rise in interest rates usually signifies an improving economy, which is good for REITs as people are spending and businesses are renting more space. Rising interest rates tend to be good for apartment REITs, as people prefer to remain as renters rather than purchase new homes. On the other hand, REITs can often take advantage of lower interest rates by reducing their 澳洲幸运5开奖号码历史查询:interest expenses and thereby increasing their profitability.

Capital market conditions are also important, namely the institutional demand for REIT equities. In the short run, this demand can overwhelm fundamentals. For example, REIT stocks did quite well in 2001 and up through 2006 despite lackluster fundamentals during some of these years, because money was flowing into the entire asset class.

At the individual REIT level, you want to see strong prospects for growth in rꦅevenue, such as rental income, related service income, and FFO. You want to see if the REIT has a unique strategy for improving occupancy and raising its rents.

Economies of Scale

REITs typically seek growth through acquisitions and further aim to realize economies of scale by assimilating inefficiently run properties. Economies of scale would be realized by a reduction in operating expenses as a percentage of revenue. But acquisitions are a double-edged sword. If a REIT cannot improve 澳洲幸运5开奖号码历史查询:occupancy rates ✃and/or raise rents, it may be forced into ill-considered acquisitions to fuel growth.

As mortgage debt plays a big role in equity value, it is worth looking at the balance sheet. Some recommend looking at leverage, such as the 澳洲幸运5开奖号码历史查询:debt-to-equity ratio. But in practice, it is difficult to tell when leverage has become excessive. It is more important to weigh the proportion of fixed-rate versus floating-rate debt. In the current high-interest-rate environment, a reduction in rates could lead to lower payments on floating debt. Conversely, in a low-interest-rate environment, a rise 🦄in rates could hurt REITs with large amounts of floating debt.

REIT Taxes

Most REIT dividends aren’t what the Internal Revenue Service (IRS) considers qualified dividends, so they are generally taxed at a higher rate. Depending on your tax bracket, qualified dividends are taxed at 0%, 15%, or 20%. However, with REITs, most dividends are taxed as ordinary income—12% to 37% in 2024 and 2025, depending on your tax bracket.

However, there may be some good news here. Since REITs are 澳洲幸运5开奖号码历史查询:pass-through businesses, any dividends that don’t count as qualified dividends may be eligible for the 20% qualified business income (QBI) deduction. For example, if you have $1,000 in ordinary REIT dividends, 澳洲幸运5开奖号码历史查询:you might owe taxes on only $800 of that.

The Bottom Line

REITs are real estate companies that must pay out high dividends to enjoy the tax benefits of REIT status. Some REITS have begun to offer the 澳洲幸运5开奖号码历史查询:reinvestmen🎀t of shareholder's dividends through the purchase of additional shares of 🍰the trඣust.

Stable income that can exceed Treasury yields combines with price volatility to off𓆉er a total return potential that rivals small-capitalization stocks. Analyzing a REIT requires investors to understand the accounting distortions caused by depreciation and to pay careful attention to macroeconomic i🦩nfluences.