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REITs

REITs (REAL ESTATE INVESTMENT TRUSTS)

WHAT IS A REIT?
A REIT is a professionally managed company that owns, and usually operates a portfolio of income
producing real estate. Most REITs have an equity value of $500 million or more. Some have many
billions is equity. Investors include individuals, endowments, pension plans, insurance companies and
others.
With REITs, the typical individual has the opportunity to diversify into a large portfolio of premium
properties that he/she would not be able to purchase individually. At the same time, this is a passive
investment with professional management in place. Any loans on the properties are totally nonrecourse
to investors.
Income generated by the REIT is available for distributions to investors, typically on a monthly basis.
The law requires that the REIT distribute 90% of taxable income each year.

 

REIT PROPERTIES
Different REITs typically focus on one property type, although some REITs may diversify into more than
one property type and/or one geographic area. Property types include Apartments(multifamily), Office
buildings, Industrial/warehouse, Healthcare, Self-storage, Hospitality and Retail.
Many of the properties are subject to long term net leases with major credit tenants (Fortune 500
companies)

 

TRADED VS. NON-TRADED REITs
Traded REITs can be bought or sold on a stock exchange just like any other stock whenever the
exchange is open. Accordingly, they are liquid. They are also closely correlated to the general securities
markets.
Non-traded REITs are not bought and sold on a national stock exchange; but, like traded REITs, they are
regulated by the SEC. Unlike traded REITs, non-traded REITs are considered an illiquid asset. Some Non-
traded REITs have a provision that may allow for quarterly liquidity at a discount. Otherwise, investors
will not receive principal back until there is a liquidity event. This could mean an outright sale of assets
to a major pension plan or other institutional buyer, sale to a traded REIT, merger with a traded REIT, or
an IPO.

 

NON-TRADED REIT ADVANTAGES

  • Monthly income potential. Monthly income from REIT distributions. The law requires that 90% of annual
    taxable income be distributed to shareholders. Distributions will increase to the extent such
    taxable income increases.
  • Appreciation potential. Any appreciation in value of the real estate should increase the value of
    the REIT shares. Investors will realize this appreciation upon liquidation of their interests.
    Diversification. Non-traded REITs are not highly correlated to the stock market. Therefore, this
    asset class should be considered a way to provide portfolio diversification and the potential for
    higher overall returns.
  • The Power of Compounding. Non-traded REITs typically offer investors a choice between 1)
    receiving monthly distributions in cash or 2) reinvesting the monthly distribution through a
    dividend reinvestment plan (DRIP program). With the DRIP program an investor benefits in 2
    ways. First, the investor can ordinarily buy additional shares at a reduced cost. Secondly, the
    investor benefits from compounding.
    For example, if you assume an original investment of $100,000 (10,000 shares at $10 per share),
    a 6% annualized distribution, and a $9.40 per share cost under DRIP, then at the end of year 3
    you would have 12,093 shares with an effective rate on the original investment equal to 7.7%.
  • “Portfolio Premium” on liquidation. Simply put, the accumulated properties are worth more
    than the sum of the value of the individual properties. Whether it’s a sale of assets or the REIT,
    merger or IPO, the parties recognize the premium value for a large portfolio of properties which
    was made possible by the hard work and expertise of the professionals that put the portfolio
    together over time.
  • “Liquidation Premium” on liquidation. There is a value premium recognized when the REIT goes
    from an illiquid to a liquid state. This occurs when the non-traded REIT sells to a traded REIT,
    merges with a traded REIT, or does an IPO.


TAX BENEFITS UNDER THE NEW TAX LAW
The “Tax Cuts & Jobs Creation Act” provides that REIT ordinary income distributions can now benefit
from a 20% tax deduction. This has the effect of reducing the highest effective tax rate from 37% to
29.6%.
Ordinarily part of the distributions to shareholders constitute a return of capital and are not taxed
currently. This stems from depreciation and amortization; and such amounts reduce the cost basis of the
investment. There may be recapture of the deferred amounts as taxable income when there is a sale;
but the advantage is that such amounts are taxed at the favorable capital gains rates, not at the higher
ordinary income rates.

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