Real Estate Investment Trusts (REITs)
The final category of pooled investments focuses on real estate. REITs give investors access to income-producing real estate without directly owning property, but the type of REIT matters significantly for liquidity and risk.
What Is a REIT?
A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing real estate.
Key requirements:
- Must distribute at least 90% of taxable income as dividends to shareholders
- This high payout requirement is what qualifies the entity as a REIT and provides the tax advantage
Tax treatment:
- REIT dividends are generally taxed as ordinary income (not qualified dividends)
- Even though REITs pay high dividends, investors do not get the lower qualified dividend tax rate
Exam Tip: Gotchas
- The 90% distribution requirement applies to ALL REITs - both exchange-listed and non-traded. This is the defining feature of a REIT, regardless of how it trades.
- REIT dividends are taxed as ordinary income, not at the lower qualified dividend rate. High yield does not mean favorable tax treatment.
Exchange-Listed REITs
Exchange-listed REITs (also called publicly traded REITs) share many characteristics with stocks:
- Trade on major stock exchanges (NYSE, Nasdaq)
- Liquid: Can be bought and sold throughout the trading day
- Transparent pricing: Market price is publicly available in real time
- Subject to market volatility: Prices fluctuate with the broader stock market, not just the underlying real estate values
Non-Traded REITs
Non-traded REITs are registered with the SEC but do not trade on any exchange. They carry significantly higher risks.
- Illiquid: Cannot be easily sold; there is no secondary market
- Difficult to value: Without a trading market, the true value of shares is uncertain
- High upfront fees: Sales commissions and offering fees typically total 9-10% of the investment
- Limited or no redemption: Investors may not be able to get their money back for 10+ years
- Distributions may mislead: Non-traded REITs sometimes pay distributions from offering proceeds or borrowings rather than from actual real estate income, which reduces share value over time
Exam Tip: Gotchas
- Non-traded REITs are registered with the SEC (they file disclosures), but they do not trade on any exchange. "Registered" does not mean "listed."
- High distributions from a non-traded REIT are not necessarily a good sign; they may come from investor capital, not property income.
Exchange-Listed vs. Non-Traded REITs
| Feature | Exchange-Listed REIT | Non-Traded REIT |
|---|---|---|
| Trades on exchange | Yes | No |
| Liquidity | High | Very low (illiquid) |
| Pricing | Transparent (market price) | Difficult to determine |
| Upfront fees | Standard brokerage commission | High (9-10% of investment) |
| Redemption | Sell on exchange anytime | Limited or unavailable |
| Valuation | Market-based | Estimated; may not reflect true value |
| Market volatility | Yes | Less correlated, but illiquidity risk |
Exam Tip: Gotchas
- If a question describes a REIT with limited liquidity and high commissions, it is a non-traded REIT.
- Non-traded REITs are frequently tested. The three key risks: illiquid, high upfront fees (9-10%), and distributions that may come from investor capital rather than real estate income.