Real estate investment trusts, or REITs, deserve a place in portfolios. REITs own malls, office buildings and other properties, and generate income from leasing the space to tenants. U.S. REITs are required to pay out at least 90 percent of their taxable income to shareholders annually, making them an attractive investment for people looking for steady income streams. Though there are better times than others to invest in REITs, most investors will want to keep a set percentage in their portfolios at all times.
As with most investments, a good time to buy REITs is when prices are low compared with earnings and future prospects look bright. Also look at dividend yields. You want a high yield, but be sure the REITs have the earnings power to continue making the dividend payouts. For most investors, it makes sense to set an allocation percentage for REITs in your overall portfolio, and to rebalance quarterly or annually to make sure it's in line.
It's possible to select individual REITs for your portfolio, but be sure you're willing to do your homework on each company first. That means reading several years' worth of financial reports, and familiarizing yourself with the company's management, properties and competitors. Among the biggest U.S. REITs are Simon Property Group and Vornado Realty Trust. Forbes puts out an annual scorecard grading REITs.
An easier way to invest in REITs is through actively managed mutual funds, or passive index funds or exchange-traded funds that hold all of the major REITs. If you buy actively managed funds, research the manager's track record and the fund's turnover rates and expenses. For most people, low-cost and tax-efficient index funds from a company such as Vanguard are the best bet for the REIT portion of portfolios.
Most financial experts agree that REITs have a place in investment portfolios as a hedge against stocks and bonds. Ibbotson Associates suggests putting somewhere between 9 percent and 22 percent of your portfolio into REITs. Longtime Yale University endowment manager David Swensen suggests 20 percent in his book "Unconventional Success." The value of your house is not included in that calculation.
REITs throw off a good deal of cash in the form of dividends--often as much as 7 percent--and U.S. tax code doesn't treat that income as favorably as qualifying stock dividends. If possible, therefore, invest in REITs through IRAs or 401(k) retirement accounts. If those accounts are already maxed out, it's OK to invest in REITs in taxable accounts, but be prepared for the annual tax bill and take steps to minimize it.