What is a REIT Formation?
A REIT (Real Estate Investment Trust) is a company that finances or owns real estate that generates money. It is involved in the raising of funds to enable these activities.
Forming a REIT is beneficial to investors, who can own shares in such real estate without having to be engaged in property management.
If you’re interested in setting up a REIT, there are some important things to know. Read the rest of this article to explore common types of REITs, how to qualify as a REIT, how to form a REIT, and how a lawyer can assist you with the process.
What are the Common Types of REITs?
There are three main types of REITs:
- Equity REITs. These manage real estate that generates income via rent more than the selling property.
- Mortgage REITS. These provide loans or invest in mortgage-backed securities.
- Hybrid REITs. These combine equity and mortgage REITs.
There are also differences in how REITs are traded.
- Public traded REITs. These are traded publicly on any exchange, and usually fall under the U.S. Securities and Exchange Commission (SEC) regulations.
- Public non-traded REITs. Instead of trading on exchanges, these are provided by brokers or financial advisors. They are also registered with the SEC.
- Private REITs. They don’t require SEC registration and aren’t traded on exchange. Private REITs are typically sold to institutional investors.
How Does a Company Qualify as a REIT?
To qualify as a REIT, a company needs to meet certain criteria, such as:
- Investing a minimum of 75 percent of their total assets in cash, U.S. Treasurys, or real estate.
- Taking a minimum of 75 percent of their gross income from renting or selling real estate, or from interest on mortgages used to finance real estate.
- Spending a minimum of 90 percent of their taxable income on shareholders (via dividends).
- Being identified as a taxable corporation that’s managed by a board of directors or trustees.
- Having a minimum of 100 shareholders. The IRS specifies that a company must have a minimum of 100 shareholders to qualify as a REIT, from the second year of the company’s operations.
- Ensuring that no greater than 50 percent of their shares are owned by five or fewer people.
How Do You Form a REIT?
REIT formation usually includes the following steps:
Choose a REIT Type
Depending on your business goals, you will choose the most suitable REIT type. This will affect your taxes and business operations, so it’s worth taking some time to consider the pros and cons of different REIT types.
Create a Corporation or Trust
You will have to set up a corporation or trust in order for your company to qualify as a REIT. This process varies in different states, but for corporations you’ll generally need to submit Articles of Incorporation and corporate bylaws to your local Secretary of State.
Write a Private Placement Memorandum (PPM)
A PPM is a legal document that will be given to investors. It’s commonly used in private sales. To disclose all important information to investors, companies must draft a PPM that includes information about their business profits and investment risks.
Search for Investors
Finding investors for private REITs means making use of broker-dealer networks. For public REITs, you can find investors via various channels, such as:
- Stock exchanges. When a REIT is listed on a public stock exchange, typical investors include retail investors and institutional investors.
- Institutional capital networks. This includes investors from index funds, real estate funds, and pension funds.
- Investment banks. REITs can work with investment banks that market their shares to large investors.
What are Common REIT Risks?
There are some common challenges to know about when forming a REIT. These include:
- Noncompliance. If the REIT isn’t compliant with asset and income tests (which are criteria companies must meet), this can result in significant tax issues or loss of REIT status.
- Market risks. If the market experiences a downturn, this can result in poor performance .
- Interest rate risks. When interest rates increase, this affects how a REIT performs.
- Liquidity risks. Non-traded REITs aren’t sold on the open market easily, which can result in challenges with turning the investment into cash.
- Industry risks. Focusing on one sector, such as hotels, can be risky. If the overall industry experiences reduced demand, this can result in poor performance.
How Can a Lawyer Help You With a REIT?
Since REITs can be risky and challenging, it’s crucial to get help with setting them up from a qualified lawyer. Here is what a lawyer can do to assist you with the process:
- Structuring the REIT so that it is legally valid and qualifies as a REIT.
- Selecting the best legal structure, such as a corporation, for your REIT goals.
- Drafting or reviewing essential documents, such as PPMs and operating agreements.
- Checking that the REIt is aligned with all securities laws.
- Managing the process of registering the REIT, such as if it’s a public REIT, so there are no mistakes.
- Guiding you on what your tax requirements will be.
- Make sure that you remain legally compliant over time.
- Spotting any legal risks you might miss to reduce your liability.
Where to Find a Lawyer for REITs
If you need to find a real estate or securities lawyer to assist you with a REIT formation, you might feel overwhelmed about cold-calling traditional law firms. There’s another option: contacting a lawyer on an online legal network.
On ContractsCounsel, one of the largest online legal marketplaces where clients connect with experienced, qualified lawyers, this process can be done online.
On the ContractsCounsel platform, you have access to more than 1,000 lawyers who can assist you with your requests. All lawyers are vetted on the platform. After reviewing the lawyers’ profiles that include information about their expertise, education, client ratings, and years of experience, you can select the best lawyer to help you with setting up your REIT. This will ensure it’s legal, structured correctly, and minimizes your risks.
