Real Estate Investment Trusts, also known simply as REITs, allow investors to profit from the real estate sector in Arizona, the United States, and even foreign nations. While REITs certainly offer their fair share of advantages, there are a number of legal considerations to assess. Whether entrepreneurs in Arizona wish to start REITs or invest in existing REITs, it is important to gain an understanding of these factors before moving forward. To discuss this subject in greater detail, consider contacting an Arizona business attorney with Harrison Law, PLLC. During a consultation, business law attorneys with real estate experience can offer personalized advice based on the circumstances of each investor or entrepreneur. Call (480) 320-2310 to get started.
Commercial REITs Defined
REITs allow investors to pool their resources, purchase real estate, and generate returns. REITs follow the business model of a mutual fund. Instead of investing in stocks, however, the company uses investor capital to invest in real estate.
Commercial REITs focus on income-producing business properties. These might include:
- Hotels
- Parking lots
- Office buildings
- Retail stores
- Healthcare facilities
- Self-storage facilities
- Cell towers
- Data centers
- Infrastructure
- Warehouses
Advantages of Commercial REITs
The average commercial space is more expensive than the average residential space. Therefore, commercial real estate is more difficult to access for the average investor – which makes commercial REITs particularly attractive for those who lack the funds to invest in this sector through traditional means. Commercial REITs generate income through lease agreements, whereas residential REITs generate income through mortgage payments or rental incomes.
REITs Are Accessible to a Wide Range of Investors
One of the key advantages of a commercial REIT is accessibility. Many investors may not have the desire or the capital to purchase entire retail spaces, industrial parks, or warehouses for lease income. REITs give these investors the opportunity to invest smaller amounts while still experiencing returns associated with the commercial real estate sector. This ensures that even lower-income investors have the opportunity to profit from the commercial real estate sector without facing high deposits or prohibitive mortgage payments. Those who start commercial REITs also benefit from this accessibility, as it allows them to reach a larger potential investor pool.
REITs Simplify Real Estate Investments
Investing in a commercial REIT is much simpler than purchasing commercial real estate outright. There is no need to manage the property, collect rent, conduct repairs, pay monthly mortgages, or deal with any other aspect of property ownership. In addition, investors can sell their shares in commercial REITs with relative ease when the fund is publicly traded.
In contrast, investors who own entire commercial real estate properties must go through an exhaustive process to sell these properties and cash in on their investments. This includes hiring realtors, listing the property, negotiating, and closing. The ease in which investors can buy and sell shares in REITs makes this investment highly “liquid.”
Commercial REITs Offer Many Advantages Over Residential REITs
Commercial REITs may offer a higher rate of return compared to residential REITs. According to the National Council of Real Estate Investment Fiduciaries (NCREIF), commercial REITs consistently outperform the S&P 500. Many investors also see commercial real estate as a safer investment compared to residential real estate because tenants are business owners rather than average homeowners. These business relationships may be more stable, and they often involve recognizable corporations with excellent track records in retail, hospitality, and infrastructure sectors. Longer lease terms may also lead to lower vacancy rates and more consistent long-term income.
Regulations Associated With Commercial REITs
The U.S. Securities and Exchange Commission (SEC) enforces a number of regulations for commercial REITs:
- REITs must have the majority of their assets and income associated with real estate
- REITs must distribute a minimum of 90% of taxable income to shareholders each year
- These distributions must be made in the form of dividends
- REITs must be managed by a board of directors or trustees
- Shares in REITs must be fully transferable
- REITs must have at least 100 shareholders after one year of operation
- A maximum of 50% of REIT shares can be held by five or less individuals during the last half of the taxable year
- REITs must invest at least 75% of total assets in real estate or cash
- 75% of REIT gross income must come from real-estate activities
Along with the aforementioned responsibilities, the SEC also details one important privilege associated with commercial REITS: A commercial REIT can deduct all dividends from its taxable income. This means that if commercial REITs pay out 100% of their taxable income to shareholders, they owe zero corporate tax each year.
Legal Requirements for Starting a Commercial REIT
All commercial REITs must be structured as corporations before transitioning to REIT status. This process includes:
Drafting a Private Placement Memorandum (PPM)
A Private Placement Memorandum or PPM includes various details of the company, including:
- The objective of the commercial REIT
- Financial information
- How profits will be handled
- Risks
- Relationships between investors and the company
A business law attorney at Harrison Law, PLLC can help companies draft PPMs.
Convert the Corporation to REIT Status
Once the owners have established the corporation, they will need to change the business structure to that of an REIT. This involves amending the certificate of incorporation. In addition, they will need to file IRS Form 1120-REIT. This form verifies that the company meets the aforementioned requirements of a REIT, such as investing the bulk of investor capital in real estate.
Taking the REIT Public
Those who start REITs often choose to take the company public. While this is not required, it may attract more investors and lead to greater growth. Once the value of a company reaches a certain amount, it may make sense to work with business law attorneys to pursue an Initial Public Offering (IPO) and begin publicly trading shares in the commercial REIT.
Where Can I Find a Business Law Attorney in Arizona?
Entrepreneurs who wish to explore opportunities associated with commercial REITs can discuss this subject further alongside Harrison Law, PLLC. Call (480) 320-2310 today to book a consultation and assess the various legal considerations associated with starting and maintaining a commercial REIT in Arizona.
© 2023 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
