In 1960, Congress passed the Real Estate Investment Trust Act, which allows individual investors to own a portion of a diversified portfolio of large institutional-quality commercial real estate through Real Estate Investment Trusts, also known as “REITs” (pronounced “reets”). A REIT’s primary business is owning and managing real estate properties such as office buildings, apartment buildings, hotels, warehouses, health care facilities, shopping malls, timberland or golf courses and other recreation facilities. REITs may focus on one or more sectors, depending on their objectives.
There are two types of REITs – Traded and Non-Traded. We will concentrate on Non-Traded.
Non-traded REITs are considered to have a low correlation to other types of exchange-traded investments, meaning that their investment performance is independent of the stock market and not directly affected by daily stock market fluctuations. They strive to keep a consistent value. Non-traded REITs are illiquid. They are most suitable for investors who have established portfolios, long-term buy-and-hold strategies, meet certain qualifications including income and sufficient liquidity for other investments.
Structurally, a REIT is set up as a company, shares of which may be purchased by investors. The funds are used by the management company to buy and manage properties. Collectively, all shareholders own small pieces of each property that the REITs own and operate. Most REITs diversify among many different factors like sector and/or location which help reduce risk in its portfolio.
The goal of a REIT is to generate income from the properties in its portfolio either through receiving rent from its tenants or from the use of the land and its natural resources. A REIT can also generate gains when a property it owns is sold at a profit.
To qualify as a REIT, the trust must have at least 100 investors (some have tens of thousands) and agree to pass on 90% of all REIT taxable income to its shareholders every year. These earnings are distributed to the shareholders as dividends, usually on a quarterly basis.
What are the benefits of investing in REITs?
Capital Appreciation – Upon the conclusion of a REIT program, The REIT may realize long term capital appreciation by selling the properties. Another option for potential appreciation may be through public listing on a stock exchange. Specific “exit strategies”
will vary by REIT according to their investment strategies.
Potential income – REITs generally pay quarterly distributions that are traditionally competitive with equity dividends. A REIT distribution may consist of income, capital gains and return of capital.
Portfolio diversification – Determining the appropriate concentration of REITs will vary by individual. According to a recent study by Ibbotson Associates, a leading authority on asset allocation, a hypothetical 10%-20% portfolio allocation in REITs may lower overall portfolio risk while possibly increasing returns for certain portfolios.
Potential tax advantages on a portion of distributions – REITs provide investors the opportunity to own an interest in real estate and potentially benefit from some tax deferral. For some investments, taxation at capital gains rates may also apply. REITs also avoid double taxation since they are not usually taxed at the corporate level.
As with all investments, check with your investment advisor and CPA to see if REITs are right for you. Find out more about diversification out of the stock market with products that may offer stable income.