What are the Benefits of Investing in Real Estate Investment Trusts
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The most obvious advantage to REITs is that by buying shares in them, you're gaining the benefits of investing in real estate, without the disadvantages of direct ownership or those of partnerships.
Real Estate Investment Trusts Give Everybody Access to Real Estate Wealth
With direct ownership of commercial real estate, you must search for a suitable property, get the seller to agree to your contract terms, come up with a downpayment (or find a seller who's willing to give you a no money down type of deal, which in and of itself is a lot of time and effort), then manage the property by yourself, find tenants, fix toilets at two o'clock in the morning or find an honest property company (Many years ago, the biggest such company in St Louis was owned by two brothers who were eventually outed as crooks. They fled to Chile, and one eventually jumped off a roof rather than face extradition by the United States. They managed thousands of properties in the city.), you run the risks of tenants eloping without paying their rent, local economic downturns and so on.
Many Wealthy People Got Rich from Real Estate, but It's Not Easy for Someone Working at a Job
Now, many people have gotten rich this way -- but it requires a lot of time and skills and it's difficult to do while you're working a full-time job.
Many other people have invested in real property through the use of partnerships, but this also has many business risks, and the risk that someday you will learn your partner has been cheating you, or you simply don't agree on important issues.
Plus, you and I as ordinary investors cannot directly own a shopping mall, golf course or hospital. With REITs, we can benefit from all that economic activity.
You can buy shares of any publicly traded REIT just by picking up the phone or mouse and putting the Buy order into your broker, just as though you wanted General Motors or Microsoft.
Real Estate Property Companies Have a Lot Less Volatility Than Most Stocks, Because Their Earnings are so Predictable
In the forty-five years since they began in the U.S., real estate investment trust companies have given their shareholders a normally low-volatility but upward sloping ride, with lots of dividends paid every quarter.
Since their underlying businesses are strictly based on real estate, they have a low correlation with the rest of the stock market.
That is, their prices don't go up or down with General Motors or Microsoft. The correlation of REITs with the overall stock market varies, but is only around .2 to .3.
This means they are good for people who understand that asset allocation can help prevent extreme swings in portfolio value.
That said, I must repeat that real estate investment companies do exhibit low volatility. If you want to double your money in a month, they're not for you. They don't go up (or down) that fast.
High Dividend Payments are the Number One Benefit of Investing in REITs
Real estate investment income varies, but dividend yields are generally from 4 to 7% paid every quarter.
What's even better, from a tax standpoint -- some of those distributions represent real estate depreciation. This is NOT taxable as ordinary dividends. Instead, it reduces your cost basis in the shares of that REIT company you own. Therefore, you will pay taxes on this only if and when you sell the shares in the REIT stock. In general, this applies to about 20-30% of the dividend checks you receive.
A REIT can make a capital gains distribution, which is then taxable based on the capital gains tax rates.
There's no guarantee for the future, but historically REIT dividend increases have exceeded the rate of inflation.
Good management teams can often grow the real estate trust company cash flow 4-6% annually.
According to Ralph L. Block in Investing in REITs, for the twenty year period ending December 2004, equity REITs had an average annual total return of 12.7%.
Individual real estate investment trust companies give you the advantage of having experienced and knowledgable management teams who have a deep knowledge of how to run that particular type of commercial real estate in that particular geographic area. So one good REIT company gives you the advantage of specialization.
REITs Allow You to Diversify
And by having the ability to buy many such companies, you can also obtain the advantage of broad diversification. You can own shares in companies that operate apartment complexes across the United States (and much of the world, for that matter).
So when apartment rents fall in Manhattan, you're collecting increased dividends from rents in Miami.
When hotel vacancies fall, you're profiting from your health care REIT.
It does years for real estate investment trust companies to become widely popular. Real estate investors tend to believe in direct ownership of properties and to distrust the stock market, so they didn't want to own commercial real estate through equity companies. And stock investors tended to look at REITs as real estate.
As a REIT Shareholder Instead of a Direct Owner of Commercial Properties, You Also get Liquidity and Estate Planning Benefits
If you own a neighborhood shopping strip, for example, and decide you'd like to use some of its value to take a world cruise, you must sell it. All of it. That involves a lengthy process of finding a seller who will give you a price you're willing to accept, and negotiating a complex contract, then having the deal close. A million things can go wrong, and even if none of them do, it'll take months if not years.
When you finally get a check, you must share a huge chunk of it with Uncle Sam. No telling when you'll take that world cruise.
If you own an equivalently large number of REIT shares, you simply call up your broker and sell just enough to fund your cruise. You will still have to share the proceeds with the IRS, but you can keep all the REIT stock shares you don't need to sell.
What if you own that strip shopping center, and plan to keep it until you die -- but you know that your wife and/or children will have to sell it when you die, just to pay the estate taxes, because you don't have enough liquid assets. Most of your net worth is tied up in that shopping center.
But if you own the equivalently high number of REIT shares, there's no problem. When you die, your wife and other heirs will have the ownership passed to them, and they'll receive a step-up in their cost basis.
That means that if they decide to sell the REIT shares they inherit from you, their cost basis will be whatever the market price was on the day you passed away. They won't have to pay any capital gains taxes on the price increases that occurred while you owned the stock.
The ING Clarion Real Estate Securities examined the FTSE NAREIT U.S. Real Estate Index Series and discovered just how beneficial REITs are for income investors.
From 1972 to the time of the study, dividends accounted for 60.6% of total average REIT return.Because 60% of REITs cut dividends in the 2008-2009 recession, and because only a few of those have since raised them to 2007 levels, there is a lot of room for dividend growth. The current (early 2011) dividend yield for REITs averages 3.5%. That could easily go up.
Next: What are the disadvantages of investing in real estate investment trusts -- no investment is perfect, even REITs
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