REITs

One of the advantages of owning real estate is that it adds to your investment mix an asset with a low correlation to stocks, bonds, and the funds that invest in them. That’s important, because when the return on securities is disappointing, the return on real estate may be much stronger. Of course, the opposite is true as well. Real estate returns may drop in periods when stocks or bonds are doing well. 

How REITs Work 

Each REIT has a management team that buys and manages the REIT’s properties and distributes income to shareholders. REITs collect rental income from tenants of the properties it owns and realize capital gains when it sells properties that have appreciated in value. A key distinction between REITs and individual real estate companies is that a REIT must acquire and develop its properties primarily to operate them as part of its own portfolio rather than to resell them once they are developed. 

REITs can be publicly held or privately owned. Public REITs must register their securities with the SEC. You can buy and sell shares of public REITs that are listed on a stock exchange in the same way you buy individual securities, closed-end funds, or ETFs. Some REITs are also sold over-the-counter (OTC), as some stocks are. REITs typically trade at prices above or below their net asset value, or what the properties are worth. Investors can also invest indirectly in REITs through mutual funds and ETFs. 

Making Money with REITs 

Most people who buy REITs do so primarily for the dividend income they distribute to investors, which by law must be at least 90% of the corporation’s taxable income. Unlike stock dividends, REIT dividend income is taxable at your ordinary income tax rate. While REIT income can increase when rents are rising and real estate is gaining value, there is always the risk that income can fall if space goes unrented or costs rise. The return on a REIT also depends on the skill of the management team and their choice of properties. 

Evaluating REITs 

While REITs resemble funds in some ways, the evaluation process for REITS is closer to the process you would use to evaluate an individual stock.  Before investing in a REIT, you’ll want to research a number of factors that can affect REIT performance, such as: 

• Management quality and corporate structure
• Anticipated total return from the REIT, estimated from the expected price change and the prevailing dividend yield
• Current dividend yields relative to other income-generating investments such as bonds or utility stocks
• Anticipated growth in earnings per share
• Underlying asset values of the real estate and/or mortgages, and other assets 

It is also valuable to be knowledgeable about the factors that impact earnings growth, or lack of it, in real estate investments generally. These include an understanding of revenue sources generally based on occupancy rates and rent prices, cost-efficiencies that may arise, and new business opportunities.

Ref: NAREIT^®, the National Association of Real Estate Investment Trusts^®