Real Estate Investment Trusts
A “REIT” is a real estate investment trust. An entity that invests in different kinds of real estate or real estate related assets. Examples include office buildings, hotels or condominiums, shopping centers, and mortgages secured by real estate. They come in three forms. The most commonly used is an “Equity REIT,” which invests in or owns real estate and earns income from the rents they collect. The other two variations of REITs are “Mortgage REITs” and “Hybrid REITs.” Mortgage REITs typically lend money to owners and developers and Hybrid REITs are basically the two above referenced REITs combined.
REITs invest in income producing properties and pass on the profit to investors via dividends. REITs must distribute at least 90% of any profit to its shareholders in order to receive preferential tax treatment.
Investors can buy, sell and trade shares of REITs similar to a normal stock. Investors in REITS look at the level of compensation of management in addition to the credibility and competency of those managers.
Advantages of a REIT
Income is generated from rent received
Access to large commercial real estate projects
Entry and exit is easy
The correlation of REITs to the major indices is low compared to other industries. Therefore, they may be an attractive addition to a portfolio based on diversification.
The value of the REIT increases as the value of the real estate also increases. Therefore, the share price will go up.
Disadvantages of a REIT
Targeted on one particular sector of real estate. If this sector does not perform well it may lead to a substantial decrease in the investor’s money.
The dividend payments are not guaranteed and the real estate market is subject to cyclical downturns.
Performance can be dependent on demographic/economic factors. An overabundance of construction activity may negatively affect performance of REITs in that area.
With 90% required to be distributed to holders each year, only 10% of annual profits can be invested back into the business. REITs grow more slowly than the average stock as a result.
REITs are not qualified to benefit from the lower 15% tax rate recently implemented by Congress. The new rate set in 2003 does not apply to dividends paid out by the REIT each year.
Careful consideration of the pros, cons, and intricacies involved with a REIT should be reviewed prior to investing.
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