Are REITs Safe Investments?

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REITs offer investors an opportunity to invest in large-scale commercial real estate projects.
REITs offer investors an opportunity to invest in large-scale commercial real estate projects. (Image: Thomas Northcut/Photodisc/Getty Images)

Several reasons make Real Estate Investment Trusts a safe asset class. Investors can buy and sell shares in REITs as they would stocks. U.S. stock exchanges list publicly-traded REITs, making them highly liquid (easily converted to cash). REIT investors benefit from dividend distributions and capital appreciation. And, REIT investors share no personal liability of the debts of the REIT, which tend to be low relative to their capital structures anyway.

Real Estate Investment Trust

An REIT is a company that invests in real estate or real estate related assets. In order for a company to qualify as an REIT with the IRS, it must pay 90 percent of its taxable earnings to shareholders each year. It must also invest 75 percent of its assets in real estate and derive 75 percent of its income from real estate investments. Congress created REITs in 1960 as a way to introduce liquidity into the commercial real estate market similar to the purchase and sale of U.S. equity securities. Through REITs, an investor can participate in the returns of large-scale, income-producing real estate.

Performance

The inclusion of REITs in the widely-followed S&P 500 Index in 2001 marked a significant event. As investments, REITs play a vital role in the economy. REIT's offer shareholder above-average dividend yields (dividend by share price), because they have to distribute 90 percent of their taxable income. According to the National Association of Real Estate Investment Trust All REIT Index, REITs delivered a dividend yield of about 5 percent in 2009, compared to slightly less than 2 percent for the S&P 500 Index, but the gap has been much higher in previous years. Over the 30-year period ending December 31, 2009, REITs provided an 11.8 percent compound annual return, compared to 11.2 percent for the S&P 500 Index and 10.4 percent for the Russell 2000 Index.

Mortgage REITs

Mortgage REITs dominated in its early stages of the REIT industry. Mortgage REITs lend money to owners and real estate developers or invest in mortgage-backed securities. A mortgage REIT doesn't manage properties or lend directly to property buyers, it typically uses the proceeds from short-term borrowings to buy mortgage-backed securities. Like a bank, a mortgage REIT makes money on the difference between its cost of borrowing and rate of return on its mortgage-backed security portfolio. The mortgage crisis of 2008 has taken its toll on REITs in general and shares of mortgage REITs have suffered as a result. On the flip side, the dividend yields of mortgage REITs are unusually high, particularly when compared to low-yielding investments, such as Treasuries.

Equity REITs

In 1986, Congress paved the way for the creation of equity REITs through the Tax Reform Act. REITs were no longer restricted to keeping ownership and management of assets separate. An equity REIT owns and manages its own properties, making money from the rents it collects. The tax changes for REITs resulted in a wave of equity REIT initial public offerings in the mid-1990s. There are about 134 publicly-traded REITs, with 83 percent being equity REITs.

Hyrbid REITs

Hybrid REITs are a combination of mortgage and equity REITs. Investors in hybrid REITs enjoy the best of both worlds. A hybrid REIT can offset its cost of borrowing with income from its rental properties, which is a helpful in a higher interest rate environment.

Insight

A REIT can be a nice addition to a well-balanced and diversified portfolio. Investing in REIT exposes you to local and overall real estate boom and bust cycles. Fortunately, REITs offer a diversified real estate investment experience because they invest in a broad spectrum of real estate property sectors, including apartment communities, office properties, shopping centers, regional malls, storage centers, industrial parks and warehouses, lodging facilities, health care facilities and natural resources. If you are considering investing in REITs, talk to an investment professional.

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