Real Estate Investment Trusts—A Long-Term Investment Strategy

Real estate investment trusts (REITs) are for-profit trusts established by Congress in 1960. Their purpose is to give small investors an opportunity to invest in large, income-producing properties.

Stocks of many public REITs are available on major stock exchanges and offer investors an efficient way of investing in real estate. Each shareholder earns a pro-rata share of the REIT profits. There are also private-owned REITs which operate in much the same manner.

Overall, these trusts are definitely a long-term investment strategy, but a good one for people who don't have the time or inclination to be full-time investors. Within the public and private REIT categories there are several types of trusts:

Equity REITs. These trusts own and operate income-producing properties (e.g. shopping centers, apartments, office buildings, warehouses, hotels, etc.). They may specialize in a certain market sector and in a certain geographic location, or they may invest nationally.

Mortgage REITs. These trusts concentrate on the financing end of the business. They tend to be real estate property owners and operators or, they provide indirect credit through buying loans (e.g. Ginnie Mae mortgage-backed securities, etc.). The revenue from these latter trusts comes mainly from interest earned on their mortgage loans.

Hybrid REITs. These trusts combine the investment strategies of both equity REITs and mortgage REITs. Qualifications for Public REITs To qualify as a public REIT, a company must, in general: Pay at least 90% of its taxable income to its shareholders every year. Have at least 100 shareholders. Invest at last 75 percent of its total assets in real estate. Derive at least 75% of its income from rent or mortgage interest from properties in its portfolio.

Advantages of Public REITS.These trusts have several advantages: There is no required minimum. They have a lower risk compared to stocks. They are a good income source and provide a consistent stream of income. No public market fluctuations As of 2005, all REITs had produced a 10.68% return over a 20-year period. (Source: National Association of Real Estate Trusts) REITs provide good dividends, but they are taxable) They offer diversification and, thus, more safety. They offer high liquidity; it's easy to enter and exit a REIT.

A REIT corporation or trust generally doesn't pay corporate income tax to the IRS or to the state.

Disadvantages of Public REITs. A downturn in a specific investment area can seriously damage a REIT investment. However, this possibility can be reduced by investing in REITs that own diversified companies within a variety of industry sectors.

Another disadvantage of public REITs is that they generally don't perform as well as the stock market on a long-term historical basis. Privately-Owned REITs These trusts possess all of the advantages of public REITs. However, they tend to generate higher income and pay out higher dividends (6-7% compared to a pubic REITs' 5-6%.

In terms of disadvantages, the upfront fees can be higher than with public REITS and such trusts are also not as liquid. In other words, it can be tougher to cash out than with public REITs.

A third potential disadvantage is limited transparency; that is, investors may not know exactly what the trustees are doing on a day-to-day basis. Methods of Investing in REITs You can buy shares of individual companies, or you can invest in diversified REIT mutual funds. It's very easy to invest through such vehicles as an IRA, Keogh, etc. You can also invest through borrowed money to buy REIT shares on margin.

Key Point: Use REITs for long-term investing strategy.