Many active real estate investors reach the point where they consider forming a REIT.
Forming a REIT – also known as a ‘real estate investment trust’ or a group investment – can be simple and straightforward.
Here are the five key steps to follow when forming a REIT.
#1 Create an LLC when forming a REIT
An LLC – or limited liability company – is the most common legal and tax entity for holding investment real estate. The Internal Revenue Services recognizes this structure, as do the laws of each State.
#2 Seek investors
Investors in the LLC are buying shares of the company, not the real estate itself. Usually – but not always – the percentage of ownership equates to the amount of capital an investor contributes.
Unless you have a strong past working relationship with the investor, you will need to have an idea of what type of property is going to be acquired, and have a P&L and cash flow analysis put together.
#3 Passive vs. active investors
Like the name suggests, a passive investor is one who puts money into the LLC and does nothing else.
In addition to putting money into the LLC, active investors also contribute their skills, time or knowledge. Sometimes this is in exchange for a greater share of the profits or cash flow, or for an increased number of shares in the LLC.
Examples of an active investor activity in a REIT include putting the mortgage into one’s name, acting as a general contractor, or managing the property.
#4 Written document
While forming an LLC is consistent from state to state, it’s best to have an attorney draw up the LLC operating agreement. An experienced real estate attorney will help you to address any unforeseen issues that may arise down the road.
#5 Distribute profits
This is the fun part. There’s profit made on the property appreciation when it is sold, and there’s the profit from the net monthly cash flow.
Remember, depending on what the LLC’s operating agreement says, these two income streams may or may not be distributed based on the percentage of stock held in the LLC.