REITs Explained

REITs, or real estate investment trusts, are companies that combine the capital of many investors to acquire or invest in income-producing commercial real estate and related assets. These real estate companies must meet a number of requirements to qualify as a REIT.

REIT stockholders typically earn a share of the income produced by the portfolio of properties through distributions or dividends. An important feature of REITs is that they must pay at least 90 percent of their REIT taxable income to stockholders in the form of distributions on an annual basis, potentially providing a consistent stream of income to investors.

Types of REITs

There are two types of REITs: publicly traded REITs and non-listed REITs.

Publicly traded REITs are liquid investments that can be bought and sold on a public exchange and are subject to share price fluctuation that may be unrelated to the underlying real estate assets.

Non-listed REITs are illiquid investments by design and experience value fluctuations related to the underlying real estate assets.

NAV, or net asset value, non-listed REITs are attractive to many investors today because they can offer more frequent repurchase or redemption options based the current per share NAV.

Potential investors can buy shares of a publicly traded REIT on an exchange, while non-listed REIT shares are typically sold through investment advisors or financial planners.

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How Does a REIT Work?

Most REITs that invest in income-producing properties, or equity REITs, have a straightforward business model: the REIT leases a property to tenants that pay rent, which is then passed to investors via distributions, a majority of which is considered tax-advantaged income.

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What is a 721 Exchange?

Internal Revenue Code (IRC) section 721 refers to a provision of the U.S. tax code that allows for tax-free transfers of income-producing real property to a real estate investment trust’s (REIT’s) operating partnership in exchange for ownership interest in the partnership.

Steps To Execute a 721 Exchange

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Investor contributes property to REIT’s operating partnership in exchange for units in operating partnership

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No gain or loss recognized to a partnership or any of its partners in the case of a contribution of property to the partnership

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Partnership interests are then redeemed for REIT shares or cash – either is a taxable event

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REIT shares can be liquidated by investors via the REIT’s redemption plan

Benefits of a REIT Portfolio Allocation

There are approximately 150 million Americans invested in REITs through 401(k)s, IRAS,
pension plans, and other investment funds.1

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Inflation Hedge

Acquiring income-producing properties with built-in rent increases or the potential to increase rents gives stockholders a unique opportunity to keep up with inflation as well as participate in capital appreciation.

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Tax Advantage

Possible elimination of “double taxation” (taxation at both the corporate and stockholder) if the REIT distributes at least 90 percent of taxable income to its stockholders each year.

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Diversification

REIT can be diversified by property type, location, tenant and/or lease term which can help smooth portfolio risk.

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Passive Investing

REIT investors own interests in income-producing properties but there are no management responsibilities to worry about.

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Transparency

Traded and public non-listed REITs are required to file financial reports with the United States Securities and Exchange Commission (SEC).

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Low Correlation

Non-listed REITs have low correlation to traded securities.

The Power of Owning Non-Correlated Investments

Including assets that have a low correlation to each other helps to reduce the amount of overall risk for a portfolio. Non-correlated investments include those that aren’t correlated with stocks, meaning the value does not follow the same ups and downs as the stock market. By combining assets that exhibit low correlation, investors can work to reduce portfolio risk without sacrificing return potential. Low or negative correlation means that investments behave differently from each other through changing market environments.


Inland’s 721 Exchange/UPREIT Resource Center

Defer and Diversify with a 721 Exchange/UPREIT Transaction

Discover This Little-Known IRS Tax-Mitigation Strategy

Section 721 of the Internal Revenue Code also allows for the deferral of capital gains by contributing real property for interests in an operating partnership of a REIT.

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1 NAREIT. November 2022 data.