The Ins and Outs of REITs

Thursday, 26 Apr 2012 07:32 AM

By Dan Weil

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Real estate investment trusts (REITs) offer investors an opportunity for hefty income, strong returns, and diversification from stocks and bonds.

REITs are real-estate-related companies that pay no corporate income tax and are thus required to pay out at least 90 percent of their income as dividends.

Most REITS now yield more than 3 percent, throwing off more income than Treasurys. Returns can be powerful. The FTSE NAREIT All Equity REIT Index has offered an average annualized return of more than 10 percent over the past 10 years, according to Money magazine.

Real estate price movements often diverge from stocks and/or bonds. And that’s why REITs can help diversify your portfolio.

With much of the real estate market failing to rebound significantly from the meltdown that began in 2007, many experts see REITs as a good value now.

“It's a bet on the recovery over the longer term and a bet on America," Richard Weiss, a fund manager for American Century Investments, tells CNBC.

REITs benefit from low interest rates on mortgages, favorable stock valuations that continue to be based on modest earnings expectations, and an improving economic outlook, he says.

But remember that REITs are just like stocks, so they can fall as well as rise. Fall is just what REITs did from the beginning of 2007 through 2008 – to the tune of almost 50 percent, according to Money.

Experts generally recommend allocating 5-10 percent of your investment portfolio to REITs, so that you will get enough return, income, and diversification, but not too much risk.

If you want automatic diversification and more risk control, go for a REIT mutual fund, rather than individual REITs. That way you will own pieces of many REITs and will suffer less if any single one of them tanks.

If you don’t like the active management style and often high fees of a mutual fund, you can choose an exchange-traded fund (ETF) instead.

REIT returns can vary greatly among sectors. For example, last year, the overall FTSE NAREIT Index generated a return of 8 percent. But within that universe, self-storage-facility REITs returned 22 percent, while lodging and resort REITs gave back 14 percent.

One sector that has been strong for the last three years is apartment REITs, which have risen thanks to the sagging home market.

"The apartment sector benefited from a shift in preference when the housing bubble broke," Kenneth Heebner, manager of CGM Realty fund, tells USA Today.

Be aware that while REITs trade like stocks, their dividend payments generally don’t qualify for the 15 percent tax applied to most stock dividends, because REITs don’t pay income taxes.

That means you will pay your ordinary income tax rate on REIT dividends, which is an argument for holding them in an IRA or 401k account, rather than in a non-retirement account.

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