What actually makes a REIT a REIT versus loose use of the term

Question

The 90 percent income distribution rule is real but it is not the whole definition, and using it alone as the test misclassifies plenty of companies. A REIT, in the strict legal sense, must be organized as a corporation or trust, be managed by directors or trustees, have transferable shares, have at least 100 shareholders, derive most of its income from real estate, and hold most of its assets in real estate, in addition to distributing at least 90 percent of taxable income to shareholders. Homebuilders and third party property managers fail the asset and income tests even though they operate in real estate, since their income comes from development sales or service fees rather than rental income and real estate holdings. A fund holding REIT shares is a REIT fund, not a REIT itself. For a watchlist, checking a company's own tax filings for REIT election status is the reliable way to confirm classification rather than inferring it from dividend size.

Rena Guide · Accepted Answer

A REIT is a specific tax election, not a description of a business. A company elects to be treated as a real estate investment trust and in exchange for that treatment it has to keep meeting tests: most of its assets have to be real estate or real estate related, most of its income has to come from rents or mortgage interest, and it has to distribute the large majority of its taxable income to shareholders each year. The distribution requirement is the part people remember, and it's real, but on its own it doesn't make anything a REIT. A utility paying a 5 percent dividend is just a utility. Confirm the specific current tests with a tax professional if you ever need the exact thresholds, because they're statutory and they get details.

So on your list: a homebuilder sells houses, which is inventory rather than income-producing property, and it isn't a REIT. A company managing apartments for other owners is earning fee income, which is a service business. A fund holding a basket of REIT shares is a fund, usually an ETF or mutual fund, and it's a perfectly normal way to own REITs without picking one.

The loose usage you'll hit is people calling any real estate fund a REIT, including private, non-traded vehicles. Those can be genuine REITs by tax election while being nothing like a listed one, because you can't sell them on an exchange on a Tuesday afternoon. When someone in this room says public REIT, they mean shares that trade on a stock exchange. That liquidity is the whole point of the category.

brandonlee36 · Answer

The homebuilder one catches everybody. A watchlist can carry two of them for months before anyone notices that neither pays a dividend worth mentioning. Worth adding to the definition above: there is a split inside REITs between equity REITs, which own buildings and collect rent, and mortgage REITs, which own loans and collect interest. They behave completely differently when rates move. A lot of the eye watering 10 percent yields people screenshot are mortgage REITs, and the yield is that high partly because the book value can fall out from under you.

laurenkim53 · Answer

Also check what sector each one actually owns before you decide you like it. Two names can both call themselves diversified while one is mostly suburban office. Sector does more work than the REIT label does.

What actually makes a REIT a REIT versus loose use of the term

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