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Is a Real Estate Investment Trust Right for You?

The following is the beginning of a series of weekly articles in which Sheryl will provide overviews of investment options that offer alternatives to bank accounts. As with any investment that's not an insured deposit account, there are risks. Some may feel that these risks are worth it for the chance of higher yields. The focus of these articles will be on conservative investments that may appeal to some savers who want a chance of higher yields and minimal risk.

It’s been a good year for U.S. stock-exchange listed Real Estate Investment Trusts (REITs). According to the National Association of Real Estate Investment Trusts, REITs showed up the broader equity market the first three quarters of 2014, delivering 13% total return to investors, compared to roughly 8% for the S&P 500 Index total return. Globally, REITs and other publicly traded real estate investments performed well too.

Positive economic winds helped push the demand for commercial real estate. Plus, after the economic downturn when things came to a grinding halt; there is a limited supply of new properties compared to the go-go days of the real estate boom. Such factors laid the ground work for conditions favorable to REITs like occupancy, rental income, cash flow and dividend yield.

In the U.S., apartment REITs were standouts, with a 20% total return for the first three quarters, infrastructure and self-storage REITs were up 16.8% and 15%, respectively. In fact, says Keith Singer of Singer Wealth Management, "REITs have been one of the best performing asset classes over the last 15 years."

Many institutional investors keep 10-15% of their portfolios in real estate, estimates Brian Watts, director of research and strategy for First Investors Management Company.

If the numbers have your attention, here’s a primer of sorts on REITs.

What is a REIT?

A REIT owns and manages income-producing real estate. Those properties can include apartments, office buildings, hotels, shopping malls and warehouses, for example. At least 75% of gross income must come from rent, mortgage interest, or other real estate investments. They don’t pay corporate taxes and REITs must distribute at least 90% of taxable income to shareholders as dividends.

REITs are a great way for investors to add real estate into their portfolio without the burden of purchasing and managing physical real estate

REITs come in two flavors, traded and non-traded. The traded version is listed on an exchange and gives the purchaser the option to easily liquidate should the circumstances call for it, says Aaron Gilman, president and chief investment officer with IFP Wealth Management. You can buy them like stocks. Non-traded REITs you buy privately. There is no secondary market and finding a buyer can take a significant amount of time and the price is often lower than the purchase price, explains Gilman.

Along with traditional REITs you can buy mutual fund REITs and more recently, real estate Exchange-Traded Funds (ETFs).

What can a REIT do for you?

"REITs are a great way for investors to add real estate into their portfolio without the burden of purchasing and managing physical real estate," says Kimberly Goodwin, Ph.D., associate professor of finance at the University of Southern Mississippi.

She says they hold up well across a variety of economic conditions. "They experience lower overall volatility when compared to stocks because the income is tied to leases that remain in place for years and do not change much through economic downturns. They are a good hedge against inflation because lease rates rise along with overall real estate prices."

[REITs] hold up well across a variety of economic conditions

Furthermore, research, she says, indicates that over a long investment horizon, adding REITs to a portfolio may increase its return while decreasing the volatility.

Eric Meermann, a certified financial planner and portfolio manager with Palisades Hudson Financial Group explains why his firm likes to include REITs in clients’ portfolios. "There is a high appreciation potential – returns in real estate have outperformed the S&P 500 over long periods, despite lower correlation to the greater market than other asset classes," he says.

What you need to consider

Like any investment, there are drawbacks. "REITs are highly tax inefficient. Property taxes can make up nearly a quarter of operating expenses, which limits the cash that is returned to investors. Additionally, large portions of REIT dividends are considered ordinary income; if a REIT investor is in a high tax bracket, they he or she will likely be paying higher taxes on REIT dividends versus the dividends from ordinary stocks," says Meermann.

Given that fact, he says whenever possible, place REITs in tax-deferred accounts such as an IRA or 401(k) or a tax-free Roth IRA.

It is no small matter either, that non-traded REITs are illiquid and they typically have high management fees, says Braden Perry, a partner in the law firm of Kennyhertz Perry. Some experts put fees at in excess of 10%. "There has been talk of rulemaking and enforcement on these issues," he says.

While REITs typically serve as a hedge against inflation, since the value of real estate tends to improve when prices are rising, during a recession however, it’s often a different story. "During the most recent one in 2008, one Dow Jones REIT equity index lost 40% of its value," says David Bakke, a financial columnist for

During the most recent [recession] in 2008, one Dow Jones REIT equity index lost 40% of its value

Don’t believe the hype. Non-traded REITs typically tout their Share Redemption Program, as a way to pacify investors who are concerned about how they can unload shares if they want to. "What investors fail to realize is that these programs are usually severely limited in the number of shares that can be repurchased annually and most REITs also have a provision that allows them to suspend this liquidity feature upon Board approval," says Gilman.

When times get hard, the liquidity feature can be suspended and you’ll be left holding shares longer than planned. "As such, these products are often pushed by unscrupulous brokers and have been the subject of plaintiff attorneys and a hot spot for regulators," says Gilman.

Then there’s another layer of complexity. REITs’ performance can vary wildly, depending on the economic environment, not only during which you find yourself invested, but also depends on the environment the REIT purchases properties with investor proceeds and the environment the REIT intends to liquidate or go public to create liquidity for the investors that want to, says Gilman.

Is a REIT right for you?

"We provide a limited exposure to private REITs for younger clients seeking diversification and hedging, and to older/retired clients seeking income, diversification and hedging, while considering their whole portfolio," says John Ulin, managing principal and certified financial planner with Ulin & Co. Wealth Management.

Says Graig Stettner, a financial advisor with LPL Financial, "They should probably be part of a diversified portfolio, as they make up about 5% of the globe’s investable assets."

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Anonymous   |     |   Comment #1
REITs are very risky for individuals especially now of the anticipation of raising rates, they could tumble down very fast in value. The dividends are taxed as regular income to individuals and you may be hit with capital gains without receiving any compensation for it.
REITs rely on constant re-financing or new bonds issued to cover the dividend expenses and that may lower the values of REITs further. In other words, many REITs use the money of the proceeds of rentals to pay the underlying mortgage debt and borrow money to pay the dividend that must satisfy the 90% rule of the IRS code for distribution of income received in order not to pay corporate taxes.
Anonymous   |     |   Comment #2
Very unclear article. Are you talking about individual REITs, or the ETFs like Vanguard, SPDR, iShares, and Cohen &Steers to name a few? The ETFs are probably better for diversifying within the real estate sector.
Anonymous   |     |   Comment #3
Your post makes more sense than the whole article above. I agree, this no time to play with REIT, get out if you are in now.
gregk   |     |   Comment #4
In the intro to this article Ken describes REIT's as "conservative" and characterizes their risk as "minimal".  Such designations are always relative, I suppose, to how one might describe alternative investments in related terms, - but I wonder if readers here simply noting those words "conservative" and "minimal risk" associated with REIT's might be led to a gross misunderstanding.
Anonymous   |     |   Comment #5
I noticed it and that is why I agree with #1 above. This kind of articles are not for conservative investor, they always minimize the risk in order to attract more naive investors.
ChrisCD   |     |   Comment #6
I hold a small portion of my retirement account in a REIT ETF (about 5%).  It is real estate.  It goes up, it goes down, but generally has had a decent return.  I haven't actually bothered to check it in quite some time because I just don't mess with the holdings really.  I make monthly contributions and use those for re-balancing. 

I do feel like suddenly changing your investment account holdings because you are chasing yield can be extremely dangerous.  Most people make such decisions at the wrong time.  So do your research, but leave yield chasing out of the equation.
Anonymous   |     |   Comment #7
The 5% holding is a good maximum limit to stay with.  I prefer dividend paying stocks over REITS.  In most cases, stock dividends are qualified for a lower tax rate but dividends from REITS are not qualified.  However; this issue does not matter if it is inside a tax deferred IRA account.
Guest   |     |   Comment #8
It is a good article. I share it with my friends who don't know much about REIT. As for me, I hold about 15% of both stock dividend and REIT mutual funds in my IRA and Roth IRA. The REIT mutual fund goes up more than 16% this year, but the stock dividend mutual fund goes up about 8% this year. 
Anonymous   |     |   Comment #9
When instances get onerous, the liquidity characteristic may be suspended and you’ll be left holding shares longer than deliberate. "As such, these merchandise are often pushed by unscrupulous brokers and have been the subject of plaintiff attorneys and a hot spot for regulators,"
tl   |     |   Comment #13
Does anybody know if these REITs have anything to do with the LIBOR?  If so, does LIBOR come in different flavors? Or would the flavors be the same two flavors that Aaron Gilman said the REITs come in?  I don't know what LIBOR is, and nobody else seems to know either. I even called Jim Cramer on the CNBC, and I still couldn't understand it
New Homes Montgomery
New Homes Montgomery   |     |   Comment #14
Good Work!! I do appreciate for this information. Actually, i am looking for this same one and finally i found there. I read fully blog and got so many valuable tips about REITs .

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