Unfamiliar Investments: How do REITs work? | pesatalk.com

REITs collect funds through an Initial Public Offering (IPO). These funds are then used to buy, develop and manage real estate projects. ?Income is generated through renting, leasing, or selling the properties and is distributed directly to the REIT holder on a regular basis. When a REIT pays out its dividends, they?re equally distributed among shareholders as a percentage of paid-out taxable income.

REITs, just like ordinary companies, have a board of directors that is elected by the shareholders. The board is responsible for the hiring of real estate individuals to identify what projects to invest in and manage the portfolio on a day-to-day basis.

In most countries, REITs are exempt from paying income tax (usually 30%) as long as they remunerate 90% of their taxable income to shareholders. This is beneficial to shareholders as they receive higher dividends as compared to other listed companies with similar market capitalizations.

Types of REITs

When classifying REITs we have the following categories, mainly based on the types of real estate they invest in:

• Equity or Income REITs; these invest in and own properties. Consequently their income comes from rental proceeds.
• Mortgage or Development REITs; these invest in the ownership of mortgage properties. They loan money as mortgages to potential home-owners. Their revenues are generated from the interest earned on the mortgage loans.
• Hybrid REITs; these invest in properties and mortgages.

Benefits of Investing in REITs

The main benefit of REITs to investors is that they provide a tool for diversification of one?s portfolio. An investor will be able to distribute his funds between various listed companies, government securities and real estate.

Another benefit of REITs is that they provide liquidity to real estate investing. A shareholder can easily sell their stake should the real estate industry underperform. This is in comparison to the relative difficulty which a home-owner would face when trying to sell their property when house prices drop.

REITs also guarantee shareholders regular dividend payments. This is because distributing revenues among shareholders enable REITs to avoid paying income tax on the revenues they earn.

Like any other listed investment, shareholders in REITs can benefit from capital gains through share price appreciation.

REIT revenues come from real estate incomes, thus shareholder returns are usually adjusted for inflation since house prices adjust themselves in line with the cost of living.

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