What is a REIT, and how does one actually work?

The basic structure

Investors buy units in a trust. The trust owns property, directly or through partnerships. Rent and development profit flow up, expenses and fees come out, and what remains can be distributed to unitholders. A trustee holds the assets — not the manager.

One point of vocabulary, before anything else

'REIT' has a precise meaning in the Income Tax Act, and one of its conditions is that the trust's units be listed or traded on a public market. A private REIT does not meet that condition and is not a real estate investment trust for tax purposes — it is normally a unit trust that qualifies as a mutual fund trust. Nothing turns on this for the tax rules that apply to publicly traded trusts, which is why the usage persists. But it does mean that on a private offering the word describes the shape of the structure, not a tax status, and you should read it that way.

Listed versus private

A listed REIT trades on an exchange: you can normally sell on any trading day, at whatever the market will pay — which for listed Canadian REITs has often been well below the net asset value they report. A private REIT does not trade at all. Its value is a net asset value calculated periodically by, or on the instruction of, the manager, usually from appraisals. It is an estimate rather than a price anyone is obliged to pay. Redemption, where it is offered, happens on set dates under set conditions: typically at net asset value less a discount, capped per period, sometimes payable in instalments, and normally capable of being suspended altogether.

Read what a distribution is made of

A distribution is not automatically income. Amounts paid out above the income allocated to you are a return of your own capital: they reduce the adjusted cost base of your units, and once that reaches zero, further distributions are taxable capital gains. A high headline distribution funded out of offering proceeds or borrowings is not a yield, it is your money coming back with tax consequences. Ask for the composition, not the rate.

Where leverage enters

Most REITs borrow, because borrowing amplifies returns when property values rise. It also amplifies losses when they fall, and for a Muslim investor conventional borrowing raises the riba question directly. Whether and how a REIT uses debt is the first thing to establish.

What to examine

The leverage, stated as a percentage of asset value. The fee stack — management, performance, development, property management, acquisition — because they compound. Who values the assets and how often. The redemption terms in full. And who the trustee, auditor and administrator are, since independence is what protects you if the manager fails.