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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. |