Background

• A REIT works similarly to a mutual fund in that it allows investors with limited funds to combine investment dollars with those of others to obtain more buying power. The Real Estate Investment Trust Act of 1960 authorized the creation of REITs by the U.S. Congress with this purpose in mind, allowing the average investor to invest in and profit from real estate. The Internal Revenue Service established guidelines that REIT managers must follow to take advantage of special tax regulations permitted to the real estate trusts.
  
  

Identification

• A REIT, a real estate investment trust, may invest in the stock of holding companies, property management companies, directly in real estate, or mortgage-backed securities. According to the U.S. Securities and Exchange Commission, there are three types of REITs. The most common in the U.S. are equity REITs. This type of trust owns rental properties or invests in companies that own rental properties and earns income when tenants pay rents. Mortgage REITs invest in mortgage-backed securities or lend money secured by real estate or mortgages. Hybrid or combination REITs earn income by investing in both mortgages and equity.
  
  

Requirements

• The IRS requires a REIT to invest a minimum of 75 percent of the company's assets in real property or real estate-related investments such as mortgages. Additionally, the REIT must return 90 percent of taxable income to shareholders each tax year to maintain eligibility as a real estate investment trust. Investors have no guarantee when owning equities of public companies that profit will be returned.
  
  

Investing

• Participation in a REIT is available to investors in a similar manner to owning shares in a mutual fund or buying stock in a public company. Single shares of REITs trade on the market like other securities such as equities or shares in bond funds. In this manner, investors can invest directly in a single REIT. A second option available is to invest in mutual funds or exchange-trade funds, ETFs that invest in REITs. For an investor with limited capital, investing in mutual funds or ETFs that own shares in multiple real estate trusts gives the investor an opportunity to diversify across the REIT market through one or two sources and can greatly reduce the costs of trading.