What are REITs and how do they make you money?

reit-house

Real Estate Investment Trusts, commonly referred to as REITS, are specialized companies that invest in commercial real estate. They buy and actively manage many types of properties, including shopping malls, apartment buildings, office buildings, hotels, hospitals and more.  REITs generally invest in one type or property.

REITs trade on stock exchanges, just like a stock, and are generally purchased through a broker. REITS usually pay a very generous dividend. This is because they receive special tax treatment from the IRS. They are required by law to distribute most of their earnings out to shareholders in the form of dividends. In exchange the REITS, unlike publicly traded companies, do not pay corporate taxes. This also eliminates the double taxation problem that plagues stocks. Since REITs are not actually stocks but rather are investment vehicles, their dividends do not qualify for the special dividend treatment of the Bush tax cuts.

REITs are a unique investment vehicle in that they provide high current income and also provide a strong growth component, both through rising property values and the acquisition of new properties. This makes them suitable for many types of investors. Retirees invest in them for income. People who wish to participate in real estate but do not have the wherewithal to own property outright find them attractive. Others like the idea of investing in real estate but have no desire to manage property.   REITs are the answer.

In addition to owning REITs outright there are also mutual funds that invest exclusively in Real Estate Investment Trusts. These have the advantage of allowing diversification across different types of properties. The downside is that such funds have expenses that can diminish returns. They are best suited for the less risk tolerant investor seeking the safety of diversification that they provide.

Investment portfolios may have up 10% of their assets invested in REITs. Income oriented portfolios may want to go as high as 25%. As always with any security get the prospectus and review the details of the REIT’s investment style and strategy.. Pay attention to the risks the fund may face as well.

The first rule of investing is always if you can’t sleep at night with the investment, don’t make it.

If you’d like to invest in real estate but holding actual property outright is not for you, Real Estate Investment Trusts may be your solution.

Original article by James Buffington.


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