REITs are an efficient way for sponsors to invest in the commercial and residential real estate businesses. As an asset, REITs combine the best features of real estate and stocks, and they give an investor a practical and effective means to include professionally managed property in a diversified investment portfolio.

REITs were created by Congress in 1960 in an effort to allow small patrons to make investments in more sophisticated, income-producing real estate. The government believed that the average investor could only access these sophisticated properties through pooling vehicles. Consequently, REITs were designed to pool the capital of multiple investors into a single entity dedicated to real estate investment.

They were anything but an overnight sensation. REITs had to adhere to certain restrictions; initially they were allowed to own property but not manage it. This kept Wall Street money away because investors didn't like the idea of having third parties managing the assets. Nonetheless, REITs experienced a period of growth in the early 1970s, but that ended when a recession hit in the middle of the decade.

The REIT market was relatively quiet until the late 1980s, when a series of events changed the marketplace. The Tax Reform Act of 1986 had a major impact. For the first time, this law enabled REITs to operate and manage most types of income-producing commercial properties. The act also eliminated tax-motivated "paper losses" through depreciation deductions for most individual investors. This removal of real estate's tax-favored status, combined with the effect of the savings and loan crisis as well as overbuilding, led to a real estate slump in the late 1980s.

Ironically, REITs benefited from the dip in the real estate economy for two reasons. First, more REITs were formed than ever before. This growth was due to many private real estate companies struggling to survive in an environment where raising capital was difficult and they recognized that forming a REIT allowed access to public capital. Second, many investors were gambling on the real estate market. Many REIT investors thought that the real estate market had bottomed out and wanted to get on board before the market rebounded.

Domestic REITs have exploded over the past 10 to 15 years. Today, there are over 300 REITs with over $300 billion in assets. REITs own roughly a third of commercial investment properties in the United States. Although most are public, there are also many private REITs. Like stocks, public REITs are traded on the major exchanges and they've historically performed on par with other major indices like the Russell 2000 and S & P 500. They're available on every major exchange and many are included in mutual fund offerings. REITs invest in all types of real estate (e.g. hotels, malls, office buildings, even trailer parks!) directly through property purchases or mortgages.

REITs are run like most other public companies: there are corporate officers and a board of directors who answer to stakeholders. Management makes decisions on which properties to buy and to sell and often have ownership positions, and they're regional, national and international.

There are three main types of REITs: equity, mortgage and hybrid.

• Equity REITs develop, manage and invest in and own properties. Revenue from equity REITs comes principally from the rents that are charged in the buildings owned by REITs.
• Mortgage REITs center around property mortgages. These loan money to people or companies that buy real estate. Mortgage REITs also purchase existing mortgages or mortgage-backed securities. They generate revenue from the interest on the loans and don't own real estate.
• Hybrid REITs invest in both properties and mortgages. These have the qualities of both Equity and Mortgage REITs, hence the name.

In principle, the main benefits of REITs are liquidity for the real estate investor and a single level of taxation . Unlike most corporations, REITs are not taxed on the dividends paid to shareholders. The drawback associated with REITs is, because virtually all earnings are paid to shareholders, there is a limited amount of available cash. Therefore, REITs must constantly pursue capital for operations.

REITs have transformed the real estate industry and will continue to evolve. Before them, the industry lacked liquidity and was less transparent. Now they're subject to complex tax laws and like other public companies, public REITs are bound by SEC guidelines.

In order for a corporation or trust to qualify as a REIT, it must comply with certain provisions within the Internal Revenue Code. As required by the Tax Code, a REIT must:

• Be a corporation, business trust or similar association;
• Be managed by a board of directors or trustees;
• Have shares that are fully transferable;
• Have a minimum of 100 shareholders;
• Have no more than 50 percent of the shares held by five or fewer individuals during the last half of each taxable year;
• Invest at least 75 percent of the total assets in real estate assets;
• Derive at least 75 percent of gross income from rents, real property or interest on mortgages on real property;
• Derive no more than 30 percent of gross income from the sale of real property held for less than four years, securities held for less than one year or certain prohibited transactions; and pay dividends of at least 95 percent of REIT taxable income.