A REIT is similar to a mutual fund.  Many investors can pool their assets to own a participation in a number of real estate investments.  However, unlike a stock or bond, mutual fund REITs are operating companies and they generally do more than just own the properties.  This means the REIT finds the tenants, receives the rents, pays the bills and handles all other matters associated with owning real estate. 

Benefits of REITs

1. Tax Benefits

REITs have an import tax exemption.  In US, they do not need to pay federal or most state income taxes.  To receive this exemption the law requires that a REIT payout 90% of its earnings in the form of dividends to its shareholders.  These dividends are taxable to the individual investor. This stecial tax treatment allows shareholders in REITs to avoid the double taxation associated with normal corporations.

2. High Dividends

High payout leads directly to the most important investment characteristic of REITs.  They generally have yields that are well above average and are often excellent investments for investor seeking high income.

For example, publicly traded REITs currently have an average yield of nearly 6.0%, while the average yield for the stocks in the S&P 500 Index is about 1.2%.

3. Liquidity of REIT shares

 Another advantage is that REITs enjoy the high liquidity of publicly traded stocks.  Direct investments in real estate are not liquid.  You cannot sell that regional shopping mall that you own at a moment’s notice.

4. High Transparency

According the the SEC, all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions."

As with all other publicly traded companies in Canada and in the U.S., REITs are required to make regular financial disclosures to the investment community. These include quarterly and yearly audited financial results with accompanying filings to the SEC.

5. 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.

The Downside

REITs have their downsides as well.  Since REITs must pay out 90% of their earnings, they have little or nothing to reinvest in their capital.  Their growth must come from selling new shares in the company.  That allows the company to grow, but it means the ownership of the current shareholders is diluted so that the individual shareholder does not benefit from the growth in terms of stock appreciation.  Long term inflation occurs.  Dividends from a well run REIT tend to increase over time and the stock will reflect those increases.  Additionally, there are always the normal market fluctuations.  A good investor can make good profits by using the old “buy low sell high” technique.  Similar to income purducing properties, REITs, however, should be considered as income vehicles rather than speculative investments.