A Comprehensive History of REITs

The concept of Real Estate Investment Trusts (REITs) has been around for centuries, with the first recorded REIT-like entity emerging in the Netherlands in the 1600s.

In the United States, the first REIT was established in 1960 with the formation of the American Realty Trust.

REITs gained popularity in the 1960s and 1970s as a way for individuals to invest in real estate without directly owning physical properties.

The REIT structure was formalized in 1969 with the passage of the REIT Act, which exempted REITs from federal income taxes on their corporate level.

The early history of REITs is a fascinating story that dates back to the early 20th century. The real estate industry was initially exempt from double taxation, but this changed in 1936.

Private real estate trusts had been around since the 1880s, but they could avoid income taxes by passing through their income to shareholders. This all changed in 1936 when double taxation was imposed on these trusts, sparking a 30-year struggle to rid the real estate industry of this onerous tax.

The struggle was led by the real estate industry, which wanted to create a similar pass-through entity to mutual funds. These funds represented debt and equity holdings and bypassed federal income tax, creating great frustration in the real estate industry.

The real estate industry argued that they should be allowed to create a similar entity, which would eventually become the REIT. This analogy was a powerful argument that eventually led to the creation of REITs.

The first REITs were established in 1960, and the introduction of this new type of investment vehicle revolutionized the investment landscape. The REIT Act was signed into law by President Dwight D. Eisenhower as a part of the Cigar Excise Tax Extension.

The conditions for exemption from corporate taxes were strict, requiring REITs to distribute at least 95% of their taxable income to shareholders. This included rental income and capital gains, and undistributed earnings were taxable to the REIT.

The law opened up the real estate industry to small investors, who could now buy and sell shares in REITs on stock exchanges. This made it possible for individuals to diversify into a new, professionally managed asset class.

Here are the key benefits of the 1960 REIT Act:

Legislative Changes played a significant role in shaping the Real Estate Investment Trust (REIT) industry. The 1975 Amendment removed a mortgage REIT disadvantage, putting equity and mortgage REITs on an equal footing.

The Tax Reform Act of 1976 addressed issues REITs faced with operating losses, allowing them to carry over net operating losses for eight years. This change encouraged REITs to remain REITs even in bad times.

The Tax Reform Act of 1986 eliminated the double benefit of depreciation deductions and capital gains exclusions, bringing REITs onto an even keel with other investment avenues. This legislative reorientation and regulatory enhancements in the 1990s were instrumental in shaping modern REITs.

Key legislative changes included:

These legislative changes simplified REIT management, reduced overhead costs, and increased investor protection, ultimately solidifying REITs' status within the investment community.

In 1975, a significant amendment was made to the REIT law, removing a major disadvantage for mortgage REITs.

This rule change allowed mortgage REITs to foreclose on a property and sell it within two years without losing their REIT status.

The Tax Reform Act of 1976 was a significant change for REITs, allowing them to be corporations and extend the benefits of being a REIT.

One key advantage of this change was that REITs could now deduct net operating losses (NOLs) and carry them over for a longer period. This was a major improvement over the previous rules, which made it difficult for REITs to remain profitable during downturns in the real estate market.

The Act lengthened the carryover period from five years to eight years, giving REITs more time to fully deduct their NOLs going forward. This was a crucial change, as it allowed REITs to remain competitive and continue to operate even in bad times.

The Tax Reform Act of 1976 effectively leveled the playing field for REITs, making them more attractive to investors and allowing them to remain a viable option for real estate investment.

In 1993, legislation was signed that made it easier for pensions funds to invest in REITs. This change in the law had a significant impact on the real estate investment market, providing new opportunities for pension funds to diversify their investments.

Pension funds were able to take advantage of this new legislation and start investing in REITs, which allowed them to spread their risk and potentially earn higher returns.

The REIT Simplification Act of 1997 was a major legislative change that simplified REIT management and reduced overhead costs.

The Act allowed REITs to perform a small amount of formerly prohibited services, such as the installation of cable TV.

This change gave REITs more flexibility in their operations, allowing them to provide additional services to their customers.

Capital gains retained by the REIT were no longer taxed at the shareholder level, only the corporate level.

This change reduced the tax burden on REITs and their shareholders.

The Act deleted the rule that threatened the loss of REIT status if a REIT made more than 30% of its income from certain proscribed property sales, known as dealer sales.

This change removed a significant compliance risk for REITs.

The penalties for a breach of the 5/50 rule were reduced. The 5/50 rule prevents five or fewer persons from owning more than 50% of a REIT.

This change made it easier for REITs to comply with this rule.

Here are the key changes made by the REIT Simplification Act of 1997:

These changes had a significant impact on the REIT industry, making it easier for REITs to operate and reducing their overhead costs.

In 1999, the REIT Modernization Act made significant changes to the way REITs operate. The RMA reduced the amount of taxable earnings that REITs must distribute to shareholders from 95% to 90%.

This change gives REITs more flexibility in managing their finances. It also means they can retain more earnings to reinvest in their properties.

REITs can now own up to 100% of the stock in a taxable REIT subsidiary (TRS). This allows them to provide certain services on an arm's length basis.

A TRS can be a valuable asset for a REIT, enabling it to offer specialized services to its tenants. For example, a healthcare-focused REIT might use a TRS to provide medical services.

REITs can also hire an independent contractor to run healthcare properties without a lease for up to six years after a REIT re-assumes ownership. This change helps REITs transition between ownership and leasing arrangements.

The REIT Improvement Act of 2003 made some significant changes to the rules governing real estate investment trusts.

Title I of the RIA allowed REITs to make certain loans with more flexibility.

Title II of the RIA streamlined foreign investment in REITs, making the rules more consistent with those for other publicly traded US corporations.

Title III of the RIA reduced penalties for certain violations that were due to reasonable cause.

Here are the key changes made by the RIA, broken down by title:

The history of REITs has been marked by a remarkable shift towards diversification and innovation. Over the past two decades, the scope of REITs has expanded far beyond conventional real estate assets.

Non-traditional or alternative REITs have emerged, encompassing sectors like infrastructure, billboards, and even farmland. These REITs often enjoy stable cash flows backed by regulatory frameworks or long-term contracts.

Investors can tap into macroeconomic trends with these alternative REITs, whether it's the global push for sustainable energy or the rise of e-commerce necessitating logistics networks.

Rapid Growth 1970s-80s was a transformative period for REITs. Inflation rates soared, making tangible assets like real estate attractive financial safeguards.

Interest rates followed suit, drawing investors to REITs with their promise of dividend returns and capital appreciation. Many REITs, enticed by lucrative returns, ventured into risky investments.

This rapid influx of interest introduced vulnerabilities, leading to significant volatility. Regulatory intervention was necessary, resulting in a consolidative phase as the 1980s concluded.

The REIT Investment Diversification and Empowerment Act of 2007, or RIDEA, made some significant changes to the rules governing REITs.

The rules concerning dealer sales were relaxed, allowing for a longer holding period and more flexibility when adding to the property tax basis before a dealer sale. This change can help REITs navigate complex sales transactions more efficiently.

The Act also increased the limit on taxable REIT subsidiary (TRS) ownership to 25% of gross assets. This change provides more flexibility for REITs to partner with subsidiaries and expand their operations.

RIDEA rationalized the rules concerning the use of independent contractors to run health care facilities, making management more efficient. This change aligns the rules for health care facilities with those for lodging facilities.

Here are the key changes made by RIDEA:

Diversification and non-traditional innovations are revolutionizing the REIT industry. Over the past two decades, the scope of REITs has expanded far beyond conventional real estate assets.

Non-traditional REITs are investing in sectors like infrastructure, billboards, and even farmland. These REITs often enjoy stable cash flows backed by regulatory frameworks or long-term contracts.

Infrastructure REITs are providing investors with a unique blend of real estate and infrastructure exposure. They're investing in assets like transportation networks, utilities, and energy infrastructure.

Farmland REITs are capitalizing on the increasing global demand for food and the limited availability of arable land. This is a macroeconomic trend that's driving the growth of these REITs.

These alternative REITs offer several advantages, including the ability to diversify portfolios beyond traditional real estate sectors. This can potentially reduce risk for investors.

Non-traditional REITs are tapping into macroeconomic trends, such as the global push for sustainable energy and the rise of e-commerce necessitating logistics networks. They're offering investors a way to participate in these trends.

These REITs often come with unique tax advantages and financial structures. This is further enhancing their appeal to investors who are looking for new opportunities.

The excitement around REITs was palpable in the 1960s. Developers, investors, and financial advisors saw the potential for millions of small investors to participate in the real estate market without suffering double taxation.

The 1960 legislation opened up a new world of possibilities for small investors. Before this law, only wealthy individuals and large financial intermediaries enjoyed the benefits of commercial real estate investments.

The first REIT to come into existence was American Realty Trust, which began trading in 1961. This marked the beginning of a new era in real estate investing.

The industry grew slowly at first, but excitement mounted in 1965 as many new REITs were launched. This surge in new REITs helped to create a more diverse and vibrant market.

Mortgage REITs dominated the decade of 1965 to 1975, offering interest income earned by the REITs as dividends to shareholders.