What is a REIT (Real Estate Investment Trust)?

What is a REIT? A Real Estate Investment Trust is a company that owns, operates or finances income-generating real estate. The company pools capital from investors, and the investors receive dividends from the rental income and appreciation from the assets. The investors do not individually own the properties. 

High Level, How do REITs work?

In the 1960s, Congress passed an amendment that provided the impossible: access for everyday investors into commercial real estate. This was the birth of the REIT. 

Through the REIT structure, individuals could purchase shares in a pool of capital that would then be used to buy, finance, and operate any type of income producing real estate. This could be a hotel in Albuquerque or an industrial complex in Kalamazoo. 

The REITs would use the funds to purchase the assets, and in return, the investors would receive dividends from the rental income. Additionally, many of the REITs became tradable on major public stock exchanges, and as a result, it seemed like Real estate had become liquid. 

This all sounds great, but what exactly qualifies as a REIT?

Instead of giving carte-blanche to fund managers, Congress defined a very specific set of parameters as to what qualifies as a REIT. The rule, commonly referred to as the 75-75-90 rule, states the REIT must:

• Invest >75% of total assets into real estate, cash, or U.S. Treasuries
• Derive >75% of gross income from rents, interest on mortgages that finance real properties, or real estate sales
• Distribute >90% of taxable income to shareholders in the form of shareholder dividends

As a result, the focus and primary benefit of REITs is dividends. Meaning, people typically invest in REITs with the hope of receiving passive income. 

What are the Pros and Cons of Investing in a REIT?

Pros:

• Typically, a REIT is completely liquid, so you can trade into and out of it instantly
• Because you are buying into a pool of assets, concentration risk is mitigated and provides diversification across markets, asset types, and more
• Passive income from dividends paid out on a quarterly basis

Cons:

• Because of 90% of the income distributed to shareholders, the REIT offers little capital appreciation because only 10% of the income can be reinvested
• One of the primary benefits of owning real estate is tax incentives, but in a REIT your income is taxed as regular income because the REIT passes along the tax burden to the shareholders
• REITs typically make money by charging management fees and transaction fees, which eat into your returns

What are the differences between investing in a REIT vs investing in properties through mogul?

In my opinion, investing in a REIT is not real estate investing. It is a clever way of marketing to the individual unfettered access into real estate, when in fact, they are investing in a sub-par stock. At mogul, whether you are looking for real estate investing in Texas, Yucaipa Real Estate, or a number of other blue-chip options, things couldn't be more different.

While there are a large number of differences between REITs and investing in real estate through mogul, I will walk you through the primary 3:

#1: REITs do not provide tax benefits, mogul does

The IRS wrote the tax code to incentivize 2 things, among many: procreation and homeownership. While we cannot help you with the first, maybe head to hinge, we can help you with the second. 

The IRS allows you to deduct many things related to your real estate holdings including mortgage interest, operating expenses, and depreciation. This means your rental income - your mortgage interest - operating expenses - depreciation = your taxable income. Well, what is the benefit there?

Depreciation is what we call a ghost expense. Real estate investors can deduct a portion of the cost of their property over its useful life (27.5 years for residential properties and 39 years for commercial properties). This deduction reflects the building's aging and wear and tear. So, even while your property is increasing in value as home prices increase, you can use the depreciation against your income. 

As an example, let's say you purchase a $1mm property with an 80% LTV. This means you have $200k in equity in the property. Let's say rental income - operating expenses - debt service = 8% of your $ invested, so $16k per year (8% * $200k). The IRS allows you to take 60% of the property's purchase value as depreciation over a 27.5 years period. 60% * $1mm = $600k / 27.5 years = $21,818 of depreciation expense per year.

In this example, you have received $16k to your bank account from rental income. At the end of the year, you would report you received $16k in rental income, but you also report you receive $21,818 of depreciation. This means for the purposes of tax reporting you actually received a $5,818 loss ($16k - $21,818). Even though you were never charged the $21,818, you can use it against the income from the property. Additionally, the $5,818 loss can actually be used against passive income from investments outside of mogul!

With a REIT, if you received that 8%, it is 4% post taxes!

#2: REIT capital appreciation vs mogul capital appreciation

In a REIT, the capital appreciation is little to none, because more people invest in the REIT and the dividends are spread thin, not to mention the 10% rule around reinvested earnings into more real assets.

With mogul, you receive the direct benefits of the leveraged appreciation in the asset. The appreciation is passed along to you the equity owner in the property, and you can invest in additional properties using the income you receive from the property.

#3: REIT management fees are recurring and larger than mogul’s one-time platform fee

REITs typically charge a yearly management fee as % of the assets under management. This means you as the investor are charged on a recurring basis.

With mogul, we capitalize our fee in the deal meaning it does not directly impact your investment and it is capitalized one-time at the onset.

‍Conclusion

In conclusion, if you want to invest in one of the single greatest wealth generators in the US, real estate, online real estate investing with mogul is the answer.

If you want a post-tax return on par with an interest bearing savings account, invest in a REIT.