REITs, or real estate investment trusts, are securities that sell like stocks and invest directly in real estate. REITs are required to invest most of its assets in real estate and distribute 90% of their income into the hands of investors, so they typically have sky high dividend yields. Since these companies can only keep 10% of their taxable earnings to qualify as an REIT, its important to note that some of these companies may be highly leveraged (which increases risks and can have disastrous results as the financial crisis of the past year has surely taught us) since they must either sell or borrow shares to raise capital. Always know what you're getting into before making an investment choice.REITs are either mortgage or equity focused - most of the mutual funds are equity. Obviously, real estate is down huge in the past couple years and the Vanguard REIT Index ETF (VNQ) is down approximately 50% in just the last year. In my opinion, it's a good time to buy real estate at these depressed levels in most markets and sectors - using the same logic, REITs might be a good investment choice for you at this current level.
Another benefit of REITs is increased diversification due to the fact that their performance is not highly correlated with the rest of the market. In fact, REITs oftentimes move in the opposite direction and thus can provide protection against the downside and are key to true diversification. As the below graph indicates, since 1992 equity REITs have had around a 38% correlation with the S&P 500. If, however, you already own real estate, owning an REIT might be repetitive and subject you to more risk by having too many of your assets in one particular sector.
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Since REITs distribute the vast majority of their income in the form of dividends, which are typically taxed at your regular income tax rate instead of the lower qualified dividend rate of 15%, it makes the most sense to hold REITs in tax-deferred retirement accounts such as an IRA or 401(k). Having a small portion - say 10% - of your retirement equity assets in a reliable REIT might make sense. Pay attention to what types of real estate a particular company invests in - commercial, residential, etc.The performance of REITs historically even before dividends haven't been shabby either:
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The New York Times' Vivian Marino suggests looking at six key factors when analyzing a REIT: management, asset quality, growth prospects, balance sheet, value, and yield.
- Management - Since REITs are not merely investing in commercial real estate, you are actually depending on a management team to completely decide which assets are wise to buy and sell. Leaders in the field also get the first crack at numerous transactions in the sector.
- Asset Quality - If you had chosen an REIT that only invested in Florida and California, you wouldn't be so happy right now. Look for companies that invest in areas that always have demand (such as strong urban areas) and hold diverse holdings.
- Growth Prospects - Just as growth is a key component of any stock, growth for an REIT is especially important.
- Balance Sheet - Check out the F.F.O.
- Value - As with any other investment, it pays to find companies that are selling below what they should be at based on their fundamentals.
- Yield - Dividends are the most appealing aspects of REITs, but just finding the company with the highest yield isn't necessarily the best bet. However, there are some accidental high yielders out there that can really provide a good steady income stream over time.
