Real Estate Investment Trusts, commonly known as REITs, were established by Congress in 1960 to provide individuals with the opportunity to invest in income-generating real estate. These entities enable anyone to invest in properties in much the same way they purchase stocks in other industries. Similar to corporate stockholders, REIT shareholders earn a share of the income generated by real estate investments without the need to directly purchase or manage property.

How REITs Function

REITs operate within a diverse industry, offering a range of benefits. They are typically categorized into two primary types: Equity REITs and Mortgage REITs.

Equity REITs

Equity REITs own and manage various property types, such as office buildings, shopping centers, hotels, and residential complexes. Their main source of income comes from the rent collected on these properties.

Mortgage REITs

Mortgage REITs, on the other hand, focus on financing residential and commercial properties. They generate revenue primarily through the interest earned on their investments in mortgages and mortgage-backed securities.

Categories of REITs

REITs can be classified into the following categories:

• Publicly registered with the SEC and listed on major stock exchanges
• Publicly registered with the SEC but not listed or traded on major stock exchanges
• Private companies that are not registered with the SEC and do not trade on stock exchanges

No matter the type, REITs must adhere to specific regulations established by Congress. To qualify as a REIT, an entity must:

• Be structured similarly to mutual funds
• Be classified as a corporation under the Internal Revenue Code
• Have a broad base of shareholders
• Primarily own or finance real estate
• Hold real estate with a long-term investment perspective

Regulatory Framework for REITs

The IRS enforces REIT regulations and determines which entities qualify. According to the Internal Revenue Code, a REIT must comply with these key rules:

• At least 75% of the corporation’s income must come from real estate-related activities, such as rent, interest, or sales of real estate assets.
• At least 75% of the corporation’s assets must consist of real estate.
• At least 95% of the income must be passive in nature.

Additionally, REITs are required to distribute at least 90% of their taxable income to shareholders as dividends. This requirement means REITs cannot retain their earnings. Similar to mutual funds, REITs benefit from a dividends-paid deduction, ensuring no tax is levied at the entity level if all income is distributed. However, shareholders are taxed on dividends at ordinary income rates rather than the lower qualified dividend rate.

The Evolution of REITs

Over the decades, REITs and their governing regulations have evolved to meet the changing demands of the real estate sector and the broader economy. Despite these changes, REITs have consistently adhered to their original purpose as defined by Congress in 1960: to make income-producing real estate accessible to a wide range of investors. This core mission remains intact today.