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Question: What Is a REIT?

There are so many acronyms that investors have to learn, it’s hard to sort out. I hear people talking about something called REITs. What are REITs and should I have one?

A REIT or real estate investment trust is a company or security that owns a portfolio of real estate holdings. Although REIT shares trade like stocks, REITs are more like mutual funds that invest in actual real estate properties or in real estate mortgages. A REIT basically offers individual investors a way to own real estate without the headache—and much of the direct risk—of being a landlord. Plus, REITs are structured in such a way that they must pay out a certain percentage of profits to investors, so they tend to offer a nice dividend stream in good years. This makes them particularly attractive for retirement investors. A REIT may not be the right investment for everyone, but it’s definitely one to consider.

How Do REITs Work?

REITs invest in income-producing properties, and can be focused on any real estate type, from commercial office buildings. to health care facilities, to hotels, to shopping malls and beyond. Each REIT will generally invest in a specific type of real estate holding.

Two Types of REITS

REITS come in two varieties. Equity REITs or Mortgage REITs.

Equity REITs are the most common type, representing about 90% of the REIT market according to the National Association of Real Estate Investment Trusts. These REITs own and operate the real estate they invest in. But these are not real estate investments that will be sold. REITs must invest in properties that produce income, which means they make their money off of rent.

Mortgage REITs represent the other 10% of the REIT market. These structures borrow money at short-term interest rates and lend it to real estate owners and operators, or simply invest in mortgage-backed securities. These REITs make money on the interest generated from the loans or investments, and they themselves are sensitive to interest rate swings.

To be a REIT, an investment must follow certain rules according to the Internal Revenue Service. It must be taxable as a corporation, must be managed by trustees or a board of directors, have shares and a minimum of 100 shareholders, and at least 75% of the assets held by the REIT must be invested in real estate. Most importantly, REITs must pay out 90% of taxable income to shareholders. These steady dividends in good years make REITs uniquely appealing for retirement investors.

Benefits of REITs

There are a lot of things that make REITs worth considering, at least for a small portion of your investment portfolio (say, 5% to 10% at most). For one thing, REITs are generally non-correlated to other stock and bond investments. So they can help to reduce the risk in a portfolio. They can also help boost returns. Their dividends offer a reliable source of income. While REITs are required to pay out at least 90% of income as dividends, most pay 100%. From 1972 to 2010, according to NAREIT, REITs have yielded a consistent annual income of 8.3%, which help to protect investors against the ravages of inflation. According to the NAREIT website. A comparison of real estate returns over rolling five-year periods for the period from January 1976 through September 2011 further illustrates the strength of REITs’ long-term performance. Equity REITs experienced 100 five-year periods during which their average annual total returns exceeded 20%. They experienced 85 five-year periods of average annual total returns between 15% and 20%.

REITs offer the average investor an easy way to enter the real estate market because of their liquidity. This means you can move money in and out easily, and the investments do not rely on real assets needing to be bought or sold. Additionally, they are ruled by high standards of corporate governance. They must follow a lot of rules to exist, so investors have some layer of protection. However, REITs do often use leverage to buy their real estate, and their dividends can swing wildly with real estate markets, so there is some risk involved.

The content on this site is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.