As most homeowners are well aware, purchasing property may be considered an investment in real estate. Although your property does not pay out yearly dividends like a stock investment, for example, you put money into it now and when you sell it down the line, the hope is that it will be worth more than you paid for it, showing a significant return. This is considered a long-term investment and it is safer than most because it has at its base an asset that is insurable, meaning the odds that you will lose everything can be minimized. And as real estate investing goes, you may be looking to do more than simply buying your own family home or even purchasing a rental property that will bring in a passive source of income (both of which require some amount of work on your part in the way of maintenance or hiring a management company, for example). And you’ve probably been hearing a lot of buzz about Real Estate Investment Trusts (REITs), which became extremely popular when they were granted a status change that put them into their own asset class, separate from other unit investment trusts and therefore subject to different rules and regulations. So what makes them so attractive to investors?
There are a couple of reasons that smaller investors are keen on such trusts. For one thing, they are fairly stable as they are actually a collection of units – mortgages, rental properties, or both – that are owned by the trust. As a result, earnings are based on the collection of rent and/or mortgage payments. Further, there are very specific rules regarding the disbursal of these funds: 90% of taxable income to the trust must be paid out as dividends annually, meaning that this type of investment tends to show higher returns than others, with the average estimated at around 8% over the course of a 15-year investment. Considering that a 5-year CD will only net you 1-3% if you’re lucky and most stock options won’t bring in much more, it’s easy to see why these relatively low-risk investment trusts have become so popular. Plus, REIT shares are sold on the stock market. So unlike a quick property sale, divesting yourself of a REIT investment comes with only the minimal fees associated with performing a stock transaction.
Of course, there are many more advantages to consider, among them the unique laws pertaining to taxation of such income. Whereas most trusts and other types of stock are taxed at the corporate level, REITs are exempt from such taxation, provided that 90% of annual earnings are passed on to shareholders as dividends. What this means for investors is a larger return, although any payout you receive will be taxed as individual income. However, the process is fairly simple and straightforward.
At the end of the fiscal year the trust will send out a 1099-DIV form to investors showing their income, capital gains, and return of capital. The “income” portion, based on collection of mortgage and rent on the properties owned by the trust, will be taxed as income. Any monies listed under “capital gains” come from the sale of properties in the trust and you will not be taxed on them until you sell your shares. And finally, the “return of capital” has to do with losses, including decreases in property value and any expenses incurred by the trust that lower the value of shares (again, this will not come into play until you sell your shares, at which time it will reduce your basis for taxation). So you’ll likely see relatively high returns with only average taxation, which is an appealing prospect for most small investors.