|Course 503: Unconventional Equities|
|Benefits of REITs|
A real estate investment trust (REIT) is a company that owns and manages income-producing real estate. REITs were created by an act of Congress in 1960 to enable large and small investors alike to enjoy the rental income from commercial property. REITs are governed by many regulations, the most important being that they must distribute at least 90% of their taxable income to shareholders each year as dividends; the REIT is permitted to deduct dividends paid to shareholders from its taxable income. Other important regulations include:
REITs specialize by property type. They invest in most major property types with nearly two thirds of investment being in offices, apartments, shopping centers, regional malls, and industrial facilities. The rest is divided among hotels, self-storage facilities, health-care properties, and some specialty REITs that own anything from prisons, theatres, and golf courses to timberlands.
Some benefits of REITs include:
High Yields. For many investors, the main attraction of REITs has been their dividend yield. The average dividend yield for REITs was about 4.3% in September 2012, well more than the yield of the S&P 500 Index, but pretty far below the longer-term average for REITs, which had been trending in the 7%-8% range (recent REIT popularity has pushed stock prices up and yields down). Also, REIT dividends are secured by stable rents from long-term leases, and many REIT managers employ conservative leverage on the balance sheet.
Simple Tax Treatment. Unlike most partnerships, tax issues for REIT investors are fairly straightforward. Each year, REITs send Form 1099-DIV to their shareholders, containing a breakdown of the dividend distributions. For tax purposes, dividends are allocated to ordinary income, capital gains, and return of capital. As REITs do not pay taxes at the corporate level, investors are taxed at their individual tax rate for the ordinary income portion of the dividend. The portion of the dividend taxed as capital gains arises if the REIT sells assets. Return of capital, or net distributions in excess of the REIT's earnings and profits, are not taxed as ordinary income, but instead applied to reduce the shareholder's cost basis in the stock. When the shares are eventually sold, the difference between the share price and reduced tax basis is taxed as a capital gain.
Liquidity of REIT Shares. REIT shares are bought and sold on a stock exchange. By contrast, buying and selling property directly involves higher expenses and requires a great deal of effort.
Diversification. Studies have shown that adding REITs to a diversified investment portfolio increases returns and reduces risk since REITs have little correlation with the S&P 500.
Next: Drawbacks of REITs >>
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