REITs: A Way to Invest in Real Estate, Earn Income, Diversify

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Real Estate Investment Trust
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By Donna Fuscaldo

Investing in real estate isn't only for property owners and speculators. Investors get can get the benefit of diversification and earn income by investing in a real estate investment trust, or REIT.

Around since the 1960s, REITs are publicly traded companies that invest in real estate either by purchasing property directly or by buying pools of residential and commercial mortgages. Unlike publicly traded companies, however, REITs are required by law to distribute 90 percent of their earnings to their shareholders in the form of dividend payments.

%VIRTUAL-pullquote-Investors are craving and hunting for yield anywhere they can find it.%As a result, REITs become particularly attractive in a low-yield environment, where generating income from traditional investments can be challenging, says Robert Goldsborough, an analyst at Morningstar (MORN). "Investors are craving and hunting for yield anywhere they can find it," he says.

High dividend payments also make REITs appealing to older investors, who typically focus on generating income as they approach retirement. According to data from San Francisco investment firm SigFig, the median age for investors who own REITs is 54, and investors older than 55 are nearly three times more likely to own REITs than investors age 35 or younger.

Perhaps even more important than income generation is the role REITs can play in portfolio diversification. Real estate is an asset class that doesn't tend to move in the same direction, at the same time, as stocks and bonds, explains Aaron Gubin, director of research at SigFig. "By including REITs in your portfolio, you can reduce its overall volatility."

Ways to Invest

Investors can buy shares in individual REITs, or invest in a REIT fund, which invests in a basket of publicly traded REIT companies. REITs themselves can invest in mortgages -- which generate income to investors from the interest payments they collect -- or in the equity of actual properties, which generate income from rent. Hybrid REITs invest in both.

Regardless of which type of REIT an investor chooses, they should be careful to choose the appropriate allocation. SigFig's Gubin says the sweet spot is typically around 5 to 6 percent of overall holdings. If an investor's REIT allocation is too low, it will have very little diversifying impact, he explains.

Risks, Tax Implications, Fees

As with almost any asset class, there are risks associated with investing in REITs. Depending on the type of REIT or REIT fund you select, rising interest rates could affect your return, says Goldsborough. Rates remain near historic lows, but many market observers expect that they may rise this year and into next year. That could impact REITs' yields, making them less attractive for income-seeking investors, Goldsborough adds.

REITs' dividend distributions can also cause taxable events, unless they are held in a tax-advantaged account like an IRA or 401(k). "Because they have high relative dividend payouts, you would prefer not to have REITs in your taxable accounts," says Gubin.

Just like with any fund investment, investors should be aware of fees. If an investor takes a passive approach by purchasing a REIT ETF, Goldsborough recommends choosing one that tracks a well-constructed index. "You want to choose a REIT with very low fees and a significant amount of diversification," he says.

Donna Fuscaldo is a contributing writer at SigFig. Nearly a million people use SigFig to track, improve and manage over $300 billion in investments.
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