Real Estate Financing and Investing/What Are Real Estate Investment Trusts

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Real estate investment trusts (REITs) are corporations that operate much like closed end mutual funds, investing shareholders' money in diversified real estate or mortgage portfolios instead of stocks or bonds. Their shares trade on the major stock exchanges or over the counter.

By law, REITs must distribute 95 percent of their net earnings to shareholders, and in turn they are exempt from corporate taxes on income or gains.

How about REIT Yields?[edit]

Since REIT earnings are not taxed before they are distributed, you get a larger percentage of the profits than with stocks. REIT yields are high, ranging between 5 1/2 to 10 1/2 percent.

What are the Types of REITs?[edit]

There are three types of REITs: Equity REITs invest primarily in income producing properties; mortgage REITs lend funds to developers or builders; and hybrid REITs do both. Experts feel that equity REITs are the safest.

What You Should Know about REITs[edit]

Pluses:

  • Dividend income with competitive yields
  • Potential appreciation in price
  • A liquid investment in an illiquid area
  • Means of portfolio diversification and participation in a variety of real estate with minimal cash outlay

Minuses

  • Possible glut in real estate or weakening demand
  • Market risk: possible decline in share price
  • Safety: Low
  • Liquidity: Very high: shares traded on major exchanges or over the counter and therefore sold at any time
  • Taxes: Income subject to tax upon sale

How Should You Select a REIT?[edit]

Before buying any REIT, be sure to read the latest annual report, The Value Line Investment Survey or Audit Investment`s Newsletter, Realty Stock Review. For more on REITs, visit the National Association of Real Estate Investment Trusts.

Check the following points:

  • Track record: how long in business as well as solid dividend record.
  • Debt level: make sure that the unsecured debt level is low.
  • Cash flow: make sure that operating cash flow covers the dividend.
  • Adequate diversification: beware of REITs investing in only one type of property.
  • Property location: beware of geographically depressed areas.
  • Type of property: nursing homes, some apartment buildings, shopping centers presently favored; "seasoned" properties preferred.
  • Aggressive management: avoid REITs that do not upgrade properties.
  • Earnings: monitor earnings regularly; be prepared to sell when the market of property location weakens.