REAL ESTATE INVESTMENT TRUSTS

Real estate investment trusts, or REITs, are corporations or business trusts that meet federal tax law requirements to be a REIT. They function like closed-end mutual funds. REITs

generally invest in real estate and offer their investors marketability, centralized management, limited liability, and continuity of interests. Plus, REITs can avoid corporate income tax because they pass their earnings along to their shareholders. The distributions are taxed as ordinary income to the shareholder. However, they cannot pass along their losses. The type of real estate behind a REIT can vary considerably between the different issuing companies. For instance, one REIT may hold the property of hotels, while another may hold restaurants. REITs may also differ in size and origin. While some REITs may be a mix of different types of real estate, some specialize in particular kinds.

Many REITs are traded on organized stock exchanges, and therefore, will be followed and evaluated by independent researchers and firms. There are some that aren’t publicly traded, and aren’t independently evaluated. When you purchase shares of a REIT that isn’t publicly traded, there is almost no secondary market for the shares, which may result in you selling your shares at a possibly reduced rate, sometimes dramatically reduced, depending upon the buyer. While last year proved to be a poor year for stocks and mutual funds, it was a good year for REITs. Many mutual funds were struggling just to break even, but depending on which index you looked at, REITs were pulling in a total return in the mid-20-percent range. Plus, the dividend yield for many REITs last year was around 11 percent. That’s a far cry from the stocks and mutual funds that most people were invested in. Rather than lose money last year on their investments, my clients who were invested in REITs saw that segment of their portfolios make money.

Three different types of REITs exist: equity, mortgage, and hybrid. Equity REITs get their income from rents and capital gains from the property they own. Mortgage REITs derive their income primarily from the interest income from mortgage loans they enter into. Hybrid REITs are combinations of the equity and mortgage REITs. There are other ways to invest in real estate, including buying and developing land, purchasing rental properties, limited partnerships, etc. However, I usually advise my clients to invest in REITs, when it is appropriate. I feel that the centralized management and the passthrough of income, which has been as high as 11 percent, outweigh the possible advantages of direct ownership.

It’s important to note that although the income that is distributed by the REIT to its shareholders is taxable to the shareholders, it’s not when the REIT is held in a qualified retirement plan (like an IRA) and reinvested. This is because the interest can flow into a separate account. However, if the qualified plan owner decides to take the interest payments as income, they will be taxed.