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REIT stocks are shares in a real estate investment trust (REIT). The United States Congress created REITs, and with them REIT stocks, in 1960. The real estate trust is the institution on which the stock is based, and shareholders receive dividends based on the profits of the trust. An institution must fulfill several requirements to be a REIT, and in return it gains the ability to avoid corporate taxes. REITs provide individual investors with the opportunity to invest in assets that would otherwise be inaccessible.
To qualify as a REIT, an institution must hold a suitable portfolio of assets. REITs are real estate institutions. They can hold varied portfolios, but 75 percent of their assets must be in real estate. This category allows some flexibility, as real estate assets include not only actual real estate holdings but also rents and mortgages. It may make no more than 20 percent in dividends and interest from sources that have no connection to real estate.
REITs are geared toward individual investors, so they must avoid domination of its stock by large investors. There are two tests that a REIT must fulfill that relate to the number of shareholders. To pass the 100 shareholder test, stocks in the REIT must be held by at least 100 unique shareholders. To pass the 5/50 test, five or fewer individuals may not hold more than 50 percent of a REIT’s stock in the second half of the fiscal year. An institution can register with the Securities Exchange Commission as a REIT regardless of whether it is publicly traded, but it must pass both shareholder tests.
One reason a real estate company might choose to register as a REIT is the tax status that registration confers upon the company. REITs are immune to corporate taxes as long as they comply with certain regulations. The REIT may retain only 10 percent of its taxable income to cover operating costs. It must pay at least 90 percent of its taxable income to its shareholders in the form of cash dividends. As a result, the holders of REIT stocks can expect high dividend payments.
REITs allow individuals to access sectors that were unavailable before. Investing in real estate requires a large initial investment, so the real estate market was dominated by large investors. REIT stocks are instruments that break up real estate investments into shares that are within the reach of private investors. By opening new sectors, REIT stocks increase the ability of individual investors to diversify their portfolios.
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