A REIT, or real estate investment trust, is a company that owns and sometimes operates real estate properties. These properties can be apartments, senior living communities, shopping centers, offices or warehouses.
As defined by U.S. Federal income tax laws, a REIT is “any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages.” Congress established REITs in the 1960s to enable smaller investors to purchase a stake in large, income-producing real estate. Basically, REITs allow people to own real estate without the burden of actually being a landlord.
REITs follow the model of other industry investments based on the purchase of equity. They are subject to organizational and operation requirements.
Advantages of investing in REITs:
- REITs introduce less risk, since your investment is in a portfolio of properties, rather than just a single building
- REITs offer liquidity, because unlike actual real estate properties, REIT shares can be sold more easily and quickly.
- REIT investments are flexible, since shares must be fully transferable.
- REIT benefits are shared across the organization, since REITs must pay out in distributions to its shareholders at least 90% of its taxable income.
- REIT investments offer diversification, since a REIT must have at least 100 shareholders, and no more than 50% of its shares held by five or fewer individuals (during the last half of each taxable year).
- REITs provide organizational strength, since REITs must be structured as a corporation, business trust or association and be managed by a board of directors or trustees.
Edgewood REIT is designed for investors looking for current income, potential long-term growth and portfolio diversification with all the benefits of a REIT.
Edgewood REIT Glossary
If you’re interested in REIT investing, here are some terms you’ll get to know.
A
Adjusted Funds from Operations (AFFO) AFFO are usually calculated by subtracting from Funds from Operations (FFO):
- Normalized recurring expenditures 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)
- “Straight-lining” of rents
This calculation also is called Cash Available for Distribution (CAD) or Funds Available for Distribution (FAD).
Adjusted Gross Income (AGI) Interim calculation in computing income tax liability. It is computed by subtracting certain allowable adjustments from gross income.
After-Tax Return The return from an investment after the effects of taxes.
Alternative Minimum Tax A way to calculate income tax that disallows certain deductions, credits and exclusions This was intended to ensure that individuals, trusts and estates that benefit from tax preferences do not escape all federal income tax liability. People must calculate their taxes both ways and pay the greater of the two.
C
Capitalization Rate, or cap rate, 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, known as CAD or FAD, measures a REIT’s ability to generate cash and distribute dividends to shareholders. CAD is determined by subtracting normalized recurring real estate-related expenditures and other non-cash items from FFO, and often also subtracting nonrecurring expenditures.
Cost of Capital The cost of raising capital in the form of equity (common or preferred stock) or debt. The cost of equity capital generally includes both the dividend rate and 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.
E
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) Also referred to as Net Operating Income (NOI).
Equity Market Cap The market value of all of a company’s outstanding common stock.
Equity REIT A REIT that owns or has an “equity interest” in rental real estate (rather than making loans secured by real estate collateral).
F
Funds from Operations (FFO) FFO is Generally Accepted Accounting Principles (GAAP) net income plus amortization and depreciation, less any gains from the sale of real estate.
H
Hybrid REIT Combines the investment strategies of both equity REITs and mortgage REITs.
I
Implied Equity Market Cap The market value of all outstanding common stock of a company plus the value of all UPREIT partnership units as if they were converted into the REIT’s stock. It excludes convertible preferred stock, convertible debentures and warrants.
L
Leverage The amount of debt in relation to either equity capital or total capital.
M
Mortgage REIT A REIT that makes or owns loans and other obligations that are secured by real estate collateral.
N
Net Asset Value (NAV) The net “market value” of all of a company’s assets, including properties, after subtracting all of its liabilities and obligations.
P
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.
R
Real Estate Investment Trust Act of 1960 The federal law that authorized REITs. Its purpose was to allow small investors to pool real estate investments to get the same benefits of direct ownership, while also diversifying risks and obtaining professional management.
Real Estate Investment Trust (REIT) A REIT is a company dedicated to owning, and, in most cases, operating income-producing real estate, such as apartments, shopping centers, offices and warehouses. Some REITs also finance real estate.
REIT Modernization Act of 1999 Federal tax law change that allows a REIT to own up to 100% of stock of a taxable REIT subsidiary that can provide services to REIT tenants and others. The law also changed the minimum distribution requirement from 95% to 90% of a REIT’s taxable income – consistent with the rules for REITs from 1960 to 1980.
S
Straight-lining Averages tenant’s rent payments over the life of the lease. Real estate companies such as REITs “straight line” rents as required by generally accepted accounting principles.
T
Tax Reform Act of 1986 Federal law that altered the real estate investment landscape by allowing REITs to own, operate and manage most types of income-producing commercial properties. It also stopped real estate “tax shelters” that had attracted capital from investors based on the amount of losses that could be created.
Total Market Cap The total market value of a REIT’s outstanding common stock and indebtedness.
Total Return A stock’s dividend income plus capital appreciation, before taxes and commissions.
U
UPREIT The partners of the Existing Partnerships and a newly formed REIT become partners in a new partnership termed the Operating Partnership. For their respective interests in the Operating Partnership (“Units”), the partners contribute the properties from the Existing Partnership and the REIT contributes the cash proceeds from its public offering. The REIT typically is the general partner and the majority owner of the Operating Partnership Units. After a period of time (often one year), the partners may enjoy the same liquidity of the REIT shareholders by tendering their Units for either cash or REIT shares (at the option of the REIT or Operating Partnership). This conversion may result in the partners incurring the tax deferred at the UPREIT’s formation. The Unit holders may tender their Units over a period of time, thereby spreading out such tax. In addition, when a partner holds the Units until death, the estate tax rules provide that the beneficiaries may tender the Units for cash or REIT shares without paying income taxes.
