REITs or Real Estate Investment Trusts investments are an alternative to purchasing real estate directly. It’s owning real estate without the hassle. A REIT is similar to owning a stock, where it can be publicly traded on the stock market. There are also REITs mutual funds and ETFs that diversify by investing in many individual REITs.
By tax law, REITs have to return 90% of their income to their shareholders. By this setup many REITs have attractive yields. On average a REIT yields around 5 – 6%. Unlike dividend stocks which are currently taxed at maximum of 15%, REITs are taxed at your ordinary income rate. So in many cases you are best to invest in REITs in tax deferred accounts like an IRA or 401(k) to minimize taxes.
Just like real estate, REITs can invest in many categories, and/or many geographical regions. Real estate is typically broken down into these categories:
- Industrial and Office
- Lodging and Resorts
- Health Care
- Self Storage
Wikipedia has a partial list of the US based publicly traded REITs.
- Low Amount Needed To Invest – You don’t need a lot of money to start investing in a REIT. Owning a REIT index fund gives you exposure to the real estate asset class with very little money.
- Passive Investment – Directly owning a property is a business and is not true passive investment like a REIT investment
- Low Correlation – REITs historically have a low correlation to other asset classes. When stocks zig, REITs typically zag.
- Liquidity – Unlike owning a property directly, investing in a REIT can be a quick enter and quick exit if you’ve made a mistake. Traditional real estate has a long enter and exit process, so your investment isn’t liquid.
- No Tax advantages – Unlike owning a property, you do not have tax advantages, such as depreciation.
- Limited Tax To Differed Accounts – Dividend income is taxed at ordinary income. While you can put a REIT into a taxable account, your dividend is significantly reduced.
- Less Control – Unlike owning a property yourself, you have less control over the management and profit.
- Dividends Not 100% Guaranteed – Dividends can decrease and are not 100% guaranteed like we saw during the 2008-09 downturn. So in this respect it is not like owning a bond.
In most cases you are best to gain REIT exposure via an index based mutual fund or ETF. When a REIT fund is indexed, it is based upon MSCI REIT index. Which has a weighting in these categories:
So if you have other real estate investments (which can include primary residence) make sure you don’t have too much invested in residential real estate. An argument against using an index based REIT is too much allocation in one specific sector. If that is your concern, you can add specific REITs to your portfolio.
REIT Index Funds
They are many to chose from:
- iShares Cohen & Steers Realty Majors (ICF)
- Vanguard REIT Index ETF (VNQ)
- Vanguard REIT Index Fund (VGSIX)
REITs are a great alternative to owning real estate directly. While they do have some disadvantages to owning real estate directly, they are an easy way to gain exposure to real estate with very little money.