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A real estate investment trust (REIT) is a company that buys, develops, manages, and/or sells real estate such as skyscrapers, shopping malls, apartment complexes, office buildings, or housing developments. Rather than investing directly in real estate, investors of REITs invest in a professionally managed portfolio of real estate. REITs trade on the major exchanges, just like stocks. REITs make money from rental income, profits from the sale of the property, and other services provided to tenants. REITs also receive special tax considerations; they do not pay taxes as long as they pay out at least 90 percent of their net income to their investors..
Basic REIT Structure
How does a company qualify as a REIT
In order for a company to qualify as a REIT, it must comply with certain provisions within the Internal Revenue Code. As required by the Tax Code, a REIT must:
- Be structured as corporation, trust, or association
- Be managed by a board of directors or trustees
- Have the shares that are fully transferable
- Be taxable as a domestic corporation
- Not be a financial institution or an insurance company
- Be jointly owned by 100 persons or more
- Pay dividends of at least 90% of the REIT's taxable income
- No more than 50% of the shares can be held by five or fewer individuals during the last half of each taxable year
- At least 75% of total assets must be invested in real estate
- Derive at least 75% of gross income from rents or mortgage interest
- No more than 20% of its assets may consist of stocks in taxable REIT subsidiaries.
- Adjusted Funds From Operations (AFFO) - It is a computation made by analysts and investors to measure a real estate company's cash flow generated by operations. It is calculated by subtracting from Funds from Operations (FFO) both recurring expenditures that are capitalized by the REIT and then amortized, but which are necessary to maintain a REIT's properties and its revenue stream (e.g., new carpeting and drapes in apartment units, leasing expenses and tenant improvement allowances) and "straight-lining" of rents. This calculation also is called Cash Available for Distribution (CAD) or Funds Available for Distribution (FAD).
- Capitalization Rate - The capitalization rate (or "cap" rate) for a property is determined by dividing the property's net operating income by its purchase price. Generally, high cap rates indicate higher returns and greater perceived risk.
- Cash (or Funds) Available for Distribution - Cash (or Funds) available for distribution (CAD or FAD) is a measure of a REIT's ability to generate cash and to distribute dividends to its shareholders.
- Cost of Capital - The cost to a company of raising capital in the form of equity or debt. The cost of equity capital generally is considered to include both the dividend rate as well as the expected equity growth either by higher dividends or growth in stock prices. The cost of debt capital is merely the interest expense on the debt incurred.
- EBITDA - Earnings before interest, taxes, depreciation and amortization. This measure is sometimes referred to as Net Operating Income (NOI).
- Equity Market Cap - The market value of all outstanding common stock of a company.
- Funds From Operations (FFO) - The most commonly accepted and reported measure of REIT operating performance. Equal to a REIT's net income, excluding gains or losses from sales of property, and adding back real estate depreciation.
- Leverage - The amount of debt in relation to either equity capital or total capital.
- Net Asset Value (NAV) - The net "market value" of all a company's assets, including but not limited to its properties, after subtracting all its liabilities and obligations.
- Positive Spread Investing (PSI) - The ability to raise funds (both equity and debt) at a cost significantly less than the initial returns that can be obtained on real estate transactions.
- Securitization - Securitization is the process of financing a pool of similar but unrelated financial assets (usually loans or o
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