Real estate can make an interesting addition to almost any portfolio. However, few of us have the large amounts of capital needed to buy a property. And, in the current climate, it can be difficult to get approval for a loan to buy up property. Fortunately, there are alternative investments that allow you to become a real estate investor without having to overcome those two hurdles. One option is to invest in real estate related stocks, and another is to invest in REITs.
What are REITs?
A Real Estate Investment Trust (REIT) allows you to invest in a variety of real estate related investments. It?s designed to do for real estate what mutual funds do for stocks. However, unlike a mutual fund, a REIT can be listed on a public stock exchange. A REIT can be can be a corporation, an association, or an actual trust. The organization acts as an investment agent.
REITs can hold a variety of investments. They can actually own different types of income-producing property, residential and/or commercial, or even finance real estate transactions. REITs are structured in such a way that they can avoid some income taxes in the United States. In order to qualify, though, a REIT has to distribute at least 90% of its taxable income to investors. This means that the dividends paid out by a REIT can be quite generous. There are private REITs and public REITs. Most ordinary investors are likely to have more success investing in public REITs.
Additionally, it?s possible to diversify your REIT holdings geographically. There are international REITs, as well as domestic REITs. You can look for REITs that specialize in one type of real estate, or choose one that has a variety of different types of real estate. Consider what you think is most likely to provide consistent returns over time.
When choosing a REIT, you want to consider the net asset value, as well as the funds from operations and the adjusted funds from operations. It?s important to carefully consider what you choose in order to get the best possible outcome for your investment.
Advantages of REITs
The biggest advantage of the REIT is that you have the opportunity to add real estate to your investment portfolio without needing a large amount of capital. Additionally, the dividend payout can provide you with a source of income. REITs are also relatively easy to buy and sell on a stock exchange. They are more liquid than actually buying property, and you don?t tie up your money in the same way.
Risks of REITs
As you might imagine, though, there are risks involved with investing in REITs. Because they are tied to real estate, many of them lost a great deal of share value after the financial crisis of 2008. While some are showing signs of recovery, the reality is that there is always the risk of loss. If the real estate market suffers, so does the REIT. If you invest in a REIT that specializes in residential mortgages, and there are a high number of defaults, then your investment loses value.
Additionally, if you rely too heavily on the dividends for income, you might be in trouble if the value drops and the REIT stops making as much money. In some cases, particularly when you invest in a private REIT, you run into the possibility that you might not be able to sell as readily as you would like. Make sure that you understand the liquidity of the REIT before you invest.
Bottom Line
Before you invest, make sure you understand the risks involved, and consider what portion of your portfolio you want in real estate related investments. If you are looking for a way to add a little diversity to your portfolio, with the help of real estate, a REIT can be worth considering. However, carefully think about your risk tolerance, and be sure you understand your target asset allocation. As always, consider your investment goals avoid investing too much in any one asset class.
Photo from Wikimedia Commons.
Source: http://beingfrugal.net/real-estate-investing-with-reits/
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