A REIT, or Real Estate Investment Trust, is much like an equity mutual fund in that the manager of the REIT invests in a portfolio of real estate while the manager of a mutual fund invests in a portfolio of stocks or bonds. There are mutual funds and ETFs that invest in a package of REITs for greater diversification beyond investing in individual REITs if the investor has limited funds or wants that greater diversification. The REIT has been in existence since about 1962, but really gaining popularity in the late 90’s as money managers recognized the advantages and the availability of REITs.
There are several types of REITs such as equity REITs, mortgage REITs, hybrid REITs and business REITs. Most common, and the type discussed here, will be the equity REIT. The manager of the Equity REIT will pool the investors’ monies and purchase real estate according to the REIT’s objectives then rent or lease out the property. The tenants then pay rent to the REIT and the REIT, in turn, pays out dividends to the investors. If the REIT pays out at least 90% of its income, as is usually the case, to the shareholders the REIT pays no Federal income tax. The investor is taxed at ordinary income tax rates but the ‘double taxation’ effect is eliminated. If the shareholder has invested the REIT in a tax deferred account like an IRA then there are no immediate tax consequences; making an account like an IRA ideal for a REIT.
Some other advantages of the REIT investment include diversification of a portfolio. The REITs have a very low correlation with other investments; meaning they do not behave the same as, say, stocks for a given economic change. But a good REIT can provide a steady high yield income stream with potential for capital gains since, unlike a bond, there is an equity side to the REIT also. Since the investment is in real estate there could also be a built in long term inflation hedge, not available in a normal bond investment. In addition, most REITs and REIT ETFs are very liquid as they trade like stocks on the stock exchange.
The REIT is actually a ‘hybrid’ security in that it behaves somewhat like a stock and also like a fixed income investment, a bond. It has an equity side to it, like a stock, as well as the steady income stream, like the bonds. On the down side the REIT also acts like a bond as it is sensitive to interest rates and sensitive to the economic downturns like a stock. REITs are sensitive to the amount of real estate available in any given market as well.
There are a myriad of REITs and REIT mutual and ETF funds available. They may be highly diversified or specialized in specific areas such as retail space, apartments, office space, industrial, storage facilities, hotels, assisted living and nursing homes, medical facilities, and even golf courses.
So, to sum it up, a REIT could provide a portfolio with a high, stable and growing dividend yield with the opportunity for capital appreciation. Most REITs have a moderate level of risk with a low correlation with other asset classes which could reduce the overall risk of a portfolio. If you’d like to own some income producing property without the hassle of property management, look to the Real Estate Investment Trust!
If you would like more information about REITs and determine if they may be appropriate for your portfolio please contact your advisor.