REAL ESTATE INVESTMENT TRUSTS

REAL ESTATE INVESTMENT TRUSTS

In 1960, the Real Estate Investment Trust Act provided for a similar investment structure in real estate as
mutual funds provide for investing in stocks.

If a REIT distributes 90% or more of its income annually to shareholders, and otherwise qualifies under IRS
rules, the REIT is permitted to be taxed at corporate rates on only the retained earnings. The shareholders may
be taxed for the dividends received from the REIT and any capital gains.

Real Estate Investment Trusts or REITs are entities that own and in most cases operate different types of
income producing real estate or related real estate assets, typically consisting of shopping centers, office
buildings, hotels, apartments and mortgages secured by real estate. Some REITs will concentrate their holdings
specifically in one type of real estate, such as shopping centers, while others may concentrate in one region of
the country.

Some advantages of a REIT include:

1. Pooling of funds to take advantage of large investment opportunities.

2. Diversification with interests in a number of different properties .

3. REITs traded publically on the major stock exchanges can be readily traded or sold for cash.

4. Although not held true with the recent financial crisis, over time REIT's stock returns have
historically had a low correlation with the returns of other equities or from bonds.

5. Publically traded REITs must make detailed disclosures to investors along with submitting regular
financial reports to the Securities Exchange Commission offering greater transparency for the
investor.

REIT’s do come with some disadvantages especially in the area of taxation. Dividends received from a REIT
are currently taxed at a higher rate than other stock dividends. An investment in a REIT can not be used to defer
capital gains tax as may be permitted by the IRS “Section 1031 Like-Kind Exchange” rules. In addition, a REIT
can not pass tax losses through to its investors as may be possible in certain other real estate investments.

A REIT is accorded special tax treatment because most of its income is received from real estate and distributed
to the shareholders. Along with this tax advantage, REITs are subject to qualifications and limitations,
including:

1. Be structured as a corporation, trust or association and be managed by a board of director or trustees.

2. Have transferable shares or certificates of interest.

3. Be an entity taxable as a corporation.

4. Can not be a financial institution or an insurance company.

5. Be jointly owned by at least 100 persons.

6. Pay to the shareholders dividends annually of at least 90% of the REIT’s taxable income.

7. Have no more than 50% of it’s shares held by 5 or fewer individuals during the last half of each
taxable year (5/50 rule).

8. At least 75% of total investment assets must be in real estate.

9. Generate at least 75% of gross income from rents on real property or mortgage interest.

10. No more than 25% of its assets may consist of stock in taxable REIT subsidiaries.

Because the usual penalty for not meeting the qualifications is the loss of REIT status, it is suggested that
licensees contact the IRS for the most current tax law involving REITs.

Types of REITs

REITs are categorized as equity trusts, mortgage trusts (short-term or long-term) or hybrid trusts.

An equity REIT is the most common and make most of their money for investors from rents collected on its
real estate properties. Unlike other real estate companies, a REIT must acquire and develop its properties
primarily to operate them rather than to resell them after they are developed. The REIT may buy or construct
buildings, develop real estate projects, lease properties for rental income and place mortgages on its holdings.

An equity trust’s internal sources of growth capital are refinancing of its mortgage debt and retaining of capital
gains when property is sold. External sources are the public sale of its securities, acquisition of properties in
exchange for its securities, and short-term bank loans.

A mortgage REIT lends money directly to real estate owners and may invest in existing mortgages secured by
real property. Income is essentially derived from interest on these mortgages. From the investors viewpoint, this
type of REIT is similar to bond mutual funds.

A hybrid REIT combines both of the above types by owning and operating income producing real estate along
with investing their assets in mortgages.

REITs can further be broken down into publically traded and non-exchanged traded REITs. Both of these types
are filed with SEC, however only publically traded REITs have shares traded on national stock exchanges.
Separate from these two types, some REITs are private and are not freely traded as they are not registered with
the SEC. An investor pays a fixed price for each unit in a private REIT and anticipates receiving regular
dividends from income produced from rents or mortgage interest. Typically private REITs only trade during
certain windows of time when the investor can redeem units back to the issuer on terms set by the private REIT.
Many private REITs have at times suspended redemptions. These types of private REITs do not have the
disclosure requirements of other REITs and typically there is no public or independent source of performance
data available for the investor.

Like other investments, REITs carry the risk of loss of investment and can be a complicated investment
product. There are many other technical and involved provisions spelled out in federal law, Internal Revenue
Service rulings, and the California Corporations Commissioner’s regulations. In addition, tax rules can be
complex requiring contacting the IRS for the most current tax laws involving REITs. To be properly informed
beyond the general picture presented here, licensees should contact all these sources.