Real Estate Investment Trusts or REITs are a type of investment that invests in real estate (as the name suggests). These investments trade like stocks and exchange traded funds on stock exchanges but you can also buy mutual funds which invest primarily in REITs. Typically these investment funds invest in large commercial realty projects such as shopping centers and office buildings.
REITs usually have very high dividend payouts since no corporate income tax is paid by the REIT once the REIT pays out ninety percent of their taxable income to stockholders.
How to buy REITs
You can buy REITs directly on any stock exchange the same way you would buy an individual stock or ETF. Unless you are willing to research the underlying holdings of various REITs you should consider just buying an index fund or ETF that contains REITs. It is a lot easier than buying individual REITs and more diversified. Vanguard has a ETF called VNQ which has a great selection of publicly traded REITs. The expense ratio is 0.15%. Vanguard also offers a REIT index fund which is similar to the ETF except you don’t have to pay for trading fees to buy or sell. The expense ratio is 0.26%. Both the Vanguard index fund and ETF have reasonable costs.
Advantages of REITs
REITs can be beneficial for investors for a number of reasons:
- Asset allocation – Real estate is considered an asset class separate from stocks and bonds so an investor can help balance their asset allocation by allocating a small percentage of their portfolio to real estate via REITs. Typically 5% to 10% is a desired real estate allocation.
- Income – REITs usually pay out a decent income which can have low tax implications if most of it is return of capital.
- Diversification – Most investors can’t easily invest in real estate since it is expensive to buy a rental house or condo. Buying into commercial real estate is impossible for the small investor. REITs allow anybody to own some commercial real estate.
- Diversification part II – Larger REITs will have many properties in different geographic locations and tied to different industries which makes them more diversified than any one commercial property.
- Liquid – Since REITs trade like stocks they are very easy to buy and sell unlike buying or selling a real estate property.
Disadvantages of REITs
- Some individual REITs might not be that diversified so if you decide to purchase individual REITs – make sure you do your research. If the REIT is too focused in one area or industry then it might be too risky.
Feel free to sign up for a free MorningStar membership which enables you to easily look up the information behind REIT index funds and exchange traded funds as well as the costs.