What Is an REIT, and Should I Invest in One?
REITs (real estate investment trusts) resemble mutual funds, though it holds individual properties rather than stocks or bonds. An REIT's management team takes responsibility for acquiring and managing the real estate that it owns.
Investors buy shares in REITs with the goal of receiving rental income on the properties and participating in price appreciation. The advantages of investing in real estate through a REIT include getting exposure to a diversified portfolio of properties and not having to manage them yourself.
Types of REITs
REITs fall into one of two categories; they're either equity REITs or mortgage REITs.
Equity REITs typically own large commercial buildings, retail storefronts, or apartment buildings, although specialty REITs might own hotels or other properties in the hospitality industry. Some REITs focus on long-term care facilities and other properties in the medical industry.
Examples of commercial real estate owned by REITs include large, multi-floor office buildings, often used as headquarters for medium- to large-sized companies. Retail storefront properties owned by REITs include stores like WalMart, PetSmart, or Ultimate Electronics. Many of these companies lease their store locations rather than owning them.
Mortgage REITs own the debt on the properties, not the properties themselves. They operate like a mutual fund that owns mortgages and collects the payments.
A Diversifying Investment
REITs work best as part of a diversified portfolio rather than as a single investment. They have no correlation with either the stock or bond market, which means they don't necessarily work as a hedge against either stock or bond price fluctuations.
Public and Private
REITs can be publicly traded, which means they have a ticker symbol, and you can easily find their share price and dividend yield on the internet through online financial sites.
Other REITs are privately held and do not trade on any exchange. Although they are still registered securities, 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 sizeable commissions to financial salespeople who offer them.
Private REITs often present a challenge if you need to sell your shares, as no public market for the REIT exists with other buyers and sellers. 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 an extended period. These investors had their money essentially trapped in the investment.
Several regulations govern REITs and require that a REIT distribute at least 90 percent of its taxable income to shareholders. These distributions get paid out to investors 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 percent to 8 percent range but, like many investments, have no guaranteed return. In tough economic times, all properties may not be fully leased. If the REIT's portfolio of properties does not produce enough rental income, its dividend payout may be reduced or eliminated.