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 For many investors, real
estate investing starts and ends with the purchase of a home
and/or farm. Yet, by investing in only one real estate
property, you are overlooking the rewards of investing in a
multitude of other properties, such as shopping centers,
warehouses, office buildings and hotels.
Investing in a
hotel or office building may seem overwhelming to many
individual investors and often has been viewed as being only
for the wealthy. However, in 1960 the U.S. Congress made it
easier for the general public to invest in real estate by
creating real estate investment trusts (REITs). Generally
speaking, REITs are publicly traded companies that buy and
hold or fund various kinds of housing, retail or commercial
properties.
According to the National
Association of Real Estate Investment Trusts (www.nareit.com),
REITs have outperformed the Dow Jones Industrial, NASDAQ
Composite and S&P 500 during the last 30 years, with equity
REITs yielding on average more than 12 percent. Despite this
fact, REITs typically are underused and widely
misunderstood.
How REITs work
The roughly 180 publicly
traded REITs available to investors work in much the same
way as publicly traded stocks in the major stock exchanges.
In the same way that shareholders benefit from owning stock
in other corporations, the shareholder of a REIT earns
income from the dividends paid by the corporation. However,
unlike other publicly traded companies, REITs are required
to pay out at least 90 percent of their taxable income to
shareholders in the form of high-yielding dividends, making
REITs great income-earning investments. Unfortunately, these
dividends typically are taxed as ordinary income and do not
qualify for the new, lower tax rates on corporate dividends.
Because these REITs are publicly traded (like other stocks),
they also are easily convertible into cash. This offers
investors more flexibility and liquidity over investments in
individual properties. Like stocks and other investments,
REITs can and will fluctuate in value.
Another option for your
portfolio is investing in non-traded REITs. Non-traded REITs
operate in a similar fashion to publicly traded REITs but
with a couple of major differences. Non-traded REITs lack
the liquidity of traded REITs, as shares cannot be easily or
quickly sold. Financial advisers and independent brokers are
more likely to recommend non-traded REITs as long-term
investment strategy because of the reduced liquidity. In
addition, non-traded REITs have net-worth and income-level
requirements to ensure proper suitability for investors.
A professional financial
adviser can help you determine which, if either, type of
REIT is most appropriate as an investment strategy in your
personal portfolio.
Types of REITs
When choosing an REIT for
your investment portfolio, it is important to know the
different types:
Equity REITs,
which invest in actual properties or assets, are the most
common. Equity REITs generally offer the highest returns.
According to the National Association of REITs, equity REITs
had a total return of 11.95 percent during the past 20
years.
Mortgage REITs
are corporations that loan money to real estate owners or
invest in mortgage-backed securities. Mortgage REITs had an
average return of more than 6 percent during the past 20
years. However, during a 10-year period, mortgage REITs
returned nearly 11 percent.
Hybrid REITs
both own properties and make loans to real estate owners.
Additional benefits of REITs
Diversification:
Because real estate usually does not move in sync with the
bond and stock market, REITs offer investors another way to
diversify their portfolios. This diversification may help
protect your portfolio from market unpredictability. Many
REITs limit diversification within the real estate industry
by investing only in niche properties, such as hospitals, or
by geographic regions. Investing in more than one REIT or in
mutual funds that specialize in REITs gives investors more
diversification and may further limit risk.
Inflation protection:
Because landlords often raise rent when inflation rises,
equity REITs gain more income and help protect your
investments from the long-term corrosive effect of
inflation.
Management:
Every REIT has its own built-in management team, so
investors do not need to research each property’s management
team.
Shop wisely
Although REITs offer
numerous valuable benefits, they are not the right choice
for every investor.
Be aware of high yields and
debt
Although high yields are
very tempting, immediate high yields can be a warning that
the corporation is not reinvesting enough for future
property acquisitions or development, which may cut into
long-term REIT growth. Likewise, too much company debt also
will hamper the growth of your investment.
Management responsibility
Do your homework regarding
the people behind the product. Before investing in a REIT,
make sure the management has a personal stake in the
company. This information should be available in their
latest prospectus.
Seek help
Whether you are considering
a publicly traded or non-traded approach, REITs may offer an
effective way to augment your portfolio. But, like any
investment, they have their pros and cons. To help you
determine if either type of REIT is the right choice to help
you meet your long- and short-term goals, consult with a
qualified financial adviser, who can help you create or
update your comprehensive financial plan. |
