The abundance of investment vehicles out there creates a challenge for the average investor trying to grasp what they're all about. Stocks are the mainstay of investing, bonds have always been the safe place to park your money, options have increased leverage for speculators, and mutual funds are considered one of the easiest vehicles for investors. One type of investment that doesn't quite fall into these categories and is often overlooked is the real estate investment trust, or REIT.
What Is a REIT?
A REIT trust company that accumulates a pool of money, through an initial public offering (IPO), which is then used to buy, develop, manage and sell assets in real estate. The IPO is identical to any other security offering with many of the same rules regarding prospectuses, reporting requirements and regulations; however, instead of purchasing stock in a single company, the owner of one REIT unit is buying a portion of a managed pool of real estate. This pool of real estate then generates income through renting, leasing and selling of property and distributes it directly to the REIT holder on a regular basis.
Advantages
When you buy a share of a REIT, you are essentially buying a physical asset with a long expected life span and potential for income through rent and property appreciation. This contrasts with common stocks where investors are buying the right to participate in the profitability of the company through ownership. When purchasing a REIT, one is not only taking a real stake in the ownership of property via increases and decreases in value, but one is also participating in the income generated by the property. This creates a bit of a safety net for investors as they will always have rights to the property underlying the trust while enjoying the benefits of their income.
Another advantage that this product provides to the average investor is the ability to invest in real estate without the normally associated large capital and labor requirements. Furthermore, as the funds of this trust are pooled together, a greater amount of diversification is generated as the trust companies are able to buy numerous properties and reduce the negative effects of problems with a single asset. Individual investors trying to mimic a REIT would need to buy and maintain a large number of investment properties, and this generally entails a substantial amount of time and money in an investment that is not easily liquidated. When buying a REIT, the capital investment is limited to the price of the unit, the amount of labor invested is constrained to the amount of research needed to make the right investment, and the shares are liquid on regular stock exchanges.
The final, and probably the most important, advantage that REITs provide is their requirement to distribute nearly 90% of their yearly taxable income, created by income producing real estate, to their shareholders. This amount is deductible on a corporate level and generally taxed at the personal level. So, unlike with dividends, there is only one level of taxation for the distributions paid to investors. This high rate of distribution means that the holder of a REIT is greatly participating in the profitability of management and property within the trust, unlike in common stock ownership where the corporation and its board decide whether or not excess cash is distributed to the shareholder.
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