What is a REIT?

There are many types of REITs to invest in.

Commercial real estate in a city.
REITs offer an easy way to invest in real estate. PPAMPicture/ Vetta/ Getty Images

REIT is an abbreviation for "real estate investment trust". A REIT is like a mutual fund that owns individual properties rather than stocks or bonds. The REIT is responsible for acquiring and managing the real estate that it owns.

As an investor the goal is to receive rental income on the properties and to participate in price appreciation. The advantage of investing in real estate through a REIT is you get exposure to a diversified portfolio of properties and you do not have to manage them yourself.

 

Regulations

Regulations govern REITs and require that a REIT distribute at least 90% of its taxable income to shareholders. These distributions are paid out as a dividend. Because REITs pay out dividends they are often marketed as an income producing retirement investment. Dividend payouts tend to fall in the 5-8% range, but are not guaranteed. In tough economic times, all properties may not be leased out. If there is not enough rental income available, a REIT may have to reduce or eliminate it's dividend payout. 

Types of REITs

REITs fall into one of two categories; equity REITs or mortgage REITs.

Equity REITs typically own large commercial buildings, retail store fronts, or apartment buildings, although there are also specialty REITs that own hotels or other properties in the hospitality industry, and there are REITs that focus on long-term care facilities or other properties in the medical industry.

An example of commercial real estate owned by REITs would be large, multi-floor office buildings, often used as headquarters for medium to large sized companies.

An example of retail store front properties owned by REITs would be stores like WalMart, PetsMart, or Ultimate Electronics. Many of these companies lease their store locations rather than own them.

Mortgage REITs own the debt on the properties, not the property itself. They are like a mutual fund that owns mortgages, and collects the payments.

Public and Private

REITS can be publicly traded, which means they have a ticker symbol, and you can easily look up their share price and dividend yield on the internet.

Other REITS are private and do not trade on an exchange. Although they are still a registered security, private REITs do not have a ticker symbol. You must buy shares directly from the real estate company offering them (or through one of their sales representatives). Private REITs often pay high commissions to financial salespeople who offer them. They are often difficult to get out of as there is not a public market where you can easily sell your shares. Most private REITs have an exit strategy where they plan to go public, but it doesn't always work out. In 2008/2009 many investors who owned private REITs saw a significant reduction in their dividend income and could not sell their investment for a long time. Their money was essentially trapped in the investment.

As Part of a Portfolio

REITs are best used as part of a diversified portfolio rather than as a single investment.

They are not highly correlated with stocks or bonds, which means what the stock or bond market is doing will have little to nothing to do with the value of a REIT.