Investing in real estate has long been a popular strategy for building wealth. However, not everyone has the means to purchase and manage properties on their own.
Fortunately, there’s a tool you can use to enter the real estate market without the stress of property management: Real Estate Investment Trusts (REITs).
REITs have become extremely popular in the real estate investment industry over the past year. But despite their popularity, there’s still a great number of people who don’t understand how they work.
If you’re curious about how you can set up a real estate investment trust on your own, you’ve come to the right place. This blog will explore REITs and how to start one in five steps.
Real Estate Investment Trusts (REITs) Explained
Real Estate Investment Trusts (REITs) invest and manage various properties. They are companies with several investors who pool their money to build a diverse portfolio of real estate investments.
There are three common types of REITs: equity, mortgage, and hybrid trusts.
Equity REITs are the type that most people are familiar with. It’s a company that buys income-generating properties and turns them into rentals. They generate income by collecting rent, which will then be distributed to real estate investors as dividends.
Meanwhile, mortgage REITs are businesses that lend money to real estate developers. They profit from the interest that their loans earn. Lastly, hybrid REITs combine the models of both mortgage and equity REITs.
Qualifying As A REIT
For an organization to qualify as a REIT, it needs to meet the following requirements of the Internal Revenue Service (IRS):
Build and maintain an investment portfolio with a minimum of 75% of total assets in cash, real estate, or U.S. treasuries.
Produce at least 75% of gross income from rents and mortgage interest from real estate properties or sales.
Distribute at least 90% of taxable income to shareholders through annual dividends.
Operate as a taxable entity like a corporation.
It must be managed by a board of directors.
Gather at least 100 shareholders after its first year of operations.
Ensure that no more than five individuals collectively hold no more than 50% of shares.
How to Set Up A Real Estate Investment Trust in Five Steps
The first thing you need to do when setting up a REIT is to pick a type. Do you want to create an equity REIT, or are you more interested in a mortgage REIT?
Your chosen REIT type determines your company’s operations, investments, and taxes. With this in mind, we suggest you look into how each type works by doing thorough research.
Start A Corporation
According to the IRS, a business must be structured as a corporation to qualify as a REIT.
The process of forming a corporation differs from one state to another. But typically, you must submit your Articles of Incorporation and corporate bylaws to your Secretary of State.
You also have to pay a filing fee when submitting your formation documents.
Create A Private Placement Memorandum (PPM)
A Private Placement Memorandum (PPM) is a legal document you present to prospective investors when selling your REIT’s shares. It’s often referred to as an offering memorandum or document and is typically used in private transactions that involve unregistered securities.
The purpose of a PPM is to allow investors to evaluate the merits of the investment they’re about to make. They’re often written in a descriptive style so that they understand the nature of the deal they’re about to make.
With this in mind, you need to make sure that your PPM includes the following information:
The objective of your REIT.
The profiles of your management team.
The REIT’s financial information.
Method of distributing profits
Regulations on selling shares.
Potential risks of the REIT.
Look For Investors
After you create your PPM, you need to get at least 100 shareholders after your first year of operation. This is one of the most important requirements of the IRS. There have been cases where REITs lost their qualification because they couldn’t maintain 100 shareholders.
Fortunately, you can start your corporation with less than 100 shareholders. But make sure you meet this number by the time your first tax year is done.
Convert Your Corporation to A REIT
Once you fulfill the requirement of the IRS, you can convert your corporation to a REIT by submitting a Form 1129-REIT alongside your tax returns.
Creating An LLC Within A REIT
Since investing in real estate comes with many risks, some investors would put their assets into a limited liability company (LLC).
An LLC is a structure known for its strong asset protections. When a business is structured as an LLC, its owners will no longer be personally liable for any debt and other legal obligations it incurs.
Investors often place their high-risk properties under an LLC so that if someone files a claim against it, the rest of their assets won’t be affected. It’s an excellent way to protect your investment portfolio from creditors and lawsuits.
Fortunately, forming an LLC is relatively easy. Though the formation process varies from state to state, they all typically require applicants to submit their Articles of Organization to their Secretary of State.
Certain places require LLCs to file their operating agreement. But we recommend creating one, even if your state doesn’t require it.
An operating agreement governs the operations and management of your LLC. It outlines your company’s management structure, ownership interests, and operational guidelines. This document will help you ensure smooth operations and prevent conflicts from arising between investors.
It’s important to note that LLCs also have compliance requirements. Once you form an LLC, you’ll have to maintain the status of two separate organizations. This could mean more work for you and your investors.
So, before you form an LLC, we suggest you seek the advice of NCH’s legal experts.
Set Up Your Real Estate Investment Trust Today
NCH is a premier business formation service provider in Nevada. Aside from helping entrepreneurs incorporate their businesses, our legal experts also specialize in creating REITs.
Our team will guide you through setting up a REIT, from helping you meet the IRS’ requirements to forming an LLC for your assets. NCH will help you decide whether separating your properties is the best option for your REIT.
Start a REIT today and let NCH help you build your wealth. To learn more about our services, you can visit our website here or call us at 1-800-508-1729.
DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.