Navigating Real Estate Trusts
A real estate investment trust (REIT) is a popular investment vehicle founded in 1960 to give smaller investors access to large real estate deals. A REIT is a corporation that pools together money from investors to buy, manage and sell real estate properties and/or mortgages. The income from the rents and/or sales of the real estate holdings are distributed to the investors. There are three main types of REITs: publicly traded, private and non-exchange traded.
* Publicly traded are registered with the Securities and Exchange Commission (SEC) and trade on one of the major stock exchanges. This type of REIT is more liquid since it trades like a stock and generally can be bought or sold anytime.
* Private REITs are not registered with the SEC and get money only from accredited investors. These REITs are generally not liquid, with holding periods up to five years or more.
* Non-exchange traded REITs are registered with the SEC but not traded on the main stock exchanges. Depending on the REIT, it may offer liquidity or not.
There are several categories within each type of REIT:
* Equity REITs buy and manage income-producing properties such as residential, commercial and retail buildings. The goal is to maximize income as well as capital gains from sales of the properties. They can specialize in certain industries such as health care, multi-family or even certain geographical areas.
* Mortgage REITs loan money to real estate owners as a mortgage or purchase existing mortgages and mortgage-backed securities. The main goal is to maximize interest from residential and/or commercial mortgages.
* Hybrid REITs are a combination of Equity and Mortgage REITs. The goal is to maximize income and gains through a combination of rents and interest.
Here are some advantages of REITs:
* REITs are a pass-through entity where at least 90 percent of the distributions are given to the investors. Taxes are paid by the investors, not the REIT itself, so the potential profits are greater.
* Some REITs have the benefit of liquidity, diversity and access to real estate ownership without the problems a landlord may face.
* Income from REITs, also known as a revenue stream, is generally predictable, offering ongoing dividend income with the potential of capital gains when the properties are sold.
* Unlike bonds, it can potentially project against inflation by adjusting rent income with cost of living changes.
Here are some disadvantages to be aware of:
Since it is pass-through, income is considered ordinary income, not capital gains, so taxes may be higher.
* The real estate market has its ups and downs, so the revenue stream and the capital gains could fluctuate and are not guaranteed.
* For non-liquid REITs, if the value of the properties decline, then receiving your money back could take longer than expected.
Despite the recent real estate downturn, real estate has been a good asset class over the long haul with a 10.5 percent return the past 20 years compared to 7.7 percent for the S&P500. But as with any type of investment, make sure REITs fit your risk tolerance, goals and time horizon. Visit artofthinkingsmart.com for more information or talk to a financial adviser to explore REITs as a part of your portfolio.