REITS (REAL ESTATE INVESTMENT TRUSTS)

If you own your own home, then you have a stake in the real estate market. But the commercial real estate investment market moves in a different cycle than the housing market, and can provide some benefits that home ownership doesn’t. If you want a stake in the commercial real estate market, there is no easier way to invest than to buy shares of a real estate investment trust (REIT). REITs are like stocks for the commercial real estate industry. They are trusts that buy commercial properties, such as apartments, office buildings, and shopping centers that produce income. When you buy shares of a REIT, you become a part owner in all of the property holdings of the REIT.

REITs are traded like stocks on the major stock exchanges, so they provide the liquidity of stocks with the diversification and income of commercial real estate.

REITs were first approved by Congress in 1960 to offer small investors a chance to participate in the commercial real estate market. Although they were slow to catch on initially, they have become increasingly popular in recent years. There are now more than 200 REITs available on the major stock exchanges, including about 150 REITs on the New York Stock Exchange, and dozens more on the American Stock Exchange and NASDAQ market. You can buy them through any broker and follow them in the daily stock listings of many newspapers (or the Internet).

REITs have several attractive features. They pay among the highest yields of all types of investments, the dividends often increase from year to year, and they are easy to buy, sell and follow.

There are several different types of REITs available on the market:

• Equity REITs own and operate income producing real estate, such as apartments, warehouses, office buildings, hotels, and shopping centers.
• Specialized REITs focus on a particular type of property, such as shopping centers or health care facilities.
• Geographically-focused REITs specialize in a single region or metropolitan area, while others try to acquire properties throughout the country.Mortgage REITs lend money to real estate owners and operators, and raise income from the interest payments on the mortgages.
• Hybrid REITs own properties and provide loans to real estate owners.
• REITs are closely regulated, and must meet certain requirements:
• Must be managed by a board of directors
• Must pay shareholder dividends of at least 90 percent of its taxable income.
• Must invest at least 75 percent of total assets in real estate assets.
• Must derive at least 75 percent of gross income from rents from real property or interest on mortgages on real property.
• Must be managed by a board of directors
• Must have a minimum of 100 shareholders.
• Must have no more than 50 percent of the shares held by five or fewer individuals.

Who should buy REITs?

REITs are geared to both large and small investors interested in current income and a stake in the real estate market as part of a diversified portfolio.

Who should not buy REITs?

REITs would not be attractive to investors looking for capital appreciation. REITs distribute 90 to 100 percent of pre-tax earnings each year to shareholders in the form of dividends, but the value of the shares tends to change very little from year to year.

REITs also may not be appropriate for you if you don’t need the income and you want to minimize your taxes. The dividends paid by REITs are added to your total taxable income, so you will owe more taxes—unless you use REITs in your IRA or other tax-deferred retirement plan.

Return

The rate of return offered by REITs is outstanding as compared with other income-producing investments. In recent years, while money market funds were paying 1 to 2 percent and many government bonds were paying under 5 percent, many REITs were paying dividends of 6 to 12 percent. And the dividends for many

REITs increase nearly every year, providing yet another advantage over bonds and other traditional fixed-income investments.

Although most REITs provide pretty steady performance, there are risks with REITs. In a down economy, if vacancies increase in the commercial properties owned by the REIT, income could decline. In a very slow market, you could see a decline in your income as well as in the value of your REIT shares.

Upside

The biggest upside to REITs may be their high yields, but there are some other benefits as well, such as:

• Increasing stream of income. REITs often increase their dividends each year providing investors with a steadily increasing stream of income.
• Inflation hedge. Owning real estate can be an inflation hedge. Real estate often rises in value along with inflation, so the value of your investment in real dollars stays about the same regardless of inflation. And the increasing stream of income REITs provide compensates for the increasing costs of inflation.
• Professional management. Professional real estate managers run the business, select the properties, handle the maintenance and leasing and the many other intricate details of the business, while you sit home and collect your dividend checks.
• Easy to buy. Buying REITs is as easy as calling your broker or making a few clicks in your online brokerage account. REITs trade like stocks on the major stock exchanges, so they are very easy to buy and sell. They give you a chance to own real estate without evaluating properties, dealing with real estate agents and bankers, and personally maintaining the properties.
• Low Price of Admission. The cost of buying commercial real estate on your own could be millions of dollars. Even in a limited partnership real estate deal, you might be required to put up $25,000 to $100,000 or more. But with REITs, you can pick your price. If you want to buy a few hundred dollars or a few thousand dollars worth of REIT shares, you have that option. In fact, you can buy shares of two or three REITs if you want to diversify within the REIT universe. It’s all very affordable.
• Liquidity. You can buy or sell REITs whenever the stock market is in session, so you have excellent liquidity. By contrast, many limited partnerships require you to leave your money in for five to 10 yeas. Or if you own your own commercial property, selling it can be a major ordeal. With a REIT, you can buy or sell with a call to your broker or a couple of clicks in your online brokerage account.

Downside

The downside to REITs is that they provide little, if any, capital appreciation. They do provide excellent income, but that income is taxable, so it can increase your tax burden (unless you use REITs in your IRA or other tax-deferred retirement plan).

How to Buy REITs

Buying REITs is the same as buying stocks. You can buy shares of REITs through your broker or through any online broker.

Biggest Concerns

The value of your REIT shares and the dividend they pay depends on the strength of the real estate market. In a depressed real estate market, you could see the value of your shares decline. In a bad commercial real estate market, rising vacancy rates would also cut into income collected by the REIT, which would reduce the amount of your dividend.

Timing

It would be a good idea to have a small portion of REITs in your portfolio at all times because of the diversification they offer. However, they are particularly attractive during periods of low interest rates and a down stock market. Typically when stocks are faltering, real estate can buoy the portfolio. And when bond interest rates are low, REITs can provide a much better stream of income.

REITs are less attractive when the stock market is booming—since returns from REITs fall short of the average annual returns from stocks. They are also less attractive during periods of high interest rates, when you can do almost as well with government bonds and triple A corporate bonds as you would with a REIT.

For the perfect time to buy a REIT is when the economy is coming out of recession, and business is picking up. At that point, real estate prices may still be a little depressed, but business growth will soon lead to higher office and warehouse occupancy rates.

Monitoring Your REITs

You can follow your REITs exactly as you follow any stock. REIT share prices are listed in the usual stock tables in the business section of many major newspapers, USA Today, The Wall Street Journal, or Investor’s Business Daily. You can also find their current share prices on the Internet at any of the many financial Web sites that feature stock prices. Most REITs trade on the New York Stock Exchange, the American Stock Exchange or the NASDAQ market, although some are traded on the smaller over-the-counter market.

Asset Allocation

As with all types of investments, the amount of your savings that you allocate for REITs should depend on your tax situation, your financial situation, your investment goals and your threshold for risk.

Investors interested in income might want to load up on REITs, with 10 to 30 percent of your portfolio in REITs since they offer a stream of income that is among the best in the investment market.

Because they are taxable, unless you need the income, you might want to put your REITs in your tax-sheltered retirement account.

Special Considerations

When selecting a REIT, you may want to look at several factors:

• What is the dividend yield and how does that compare with other REITs? Since income is the main benefit of REITs, you may as well look for one that pays a relatively high return.
• What is its track record? Look at the REIT’s past growth record and dividend payment history. Look for a REIT that has maintained a fairly steady stock price the past few years, and, perhaps even more importantly, a steadily increasing dividend.
• Check out the company. Nearly all REITs have a Web site. Go to the Web site, check out the information on the company, its history, its management, and its investment properties. You might want to look over several REITs to compare and contrast before making a decision. If the yield is high, the track record is solid with steadily rising dividends, and the company and its management look good, that’s a good sign. However, for the sake of safety and diversification, you
• might want to spread your money around to two or three different REITs.
• How is the market for the type of properties the REIT owns? For instance, if office space or apartment units are filling up around the country, there’s a good chance that REITs that invest in those types of properties would soon see an increase in earnings. But if the economy is slowing down and vacancies are rising, you may want to avoid those REITs.