Real-estate may provide investors with a high-yield and low risk investment combination for greater total return potential to a diversified long-term portfolio.
For most people, investing in real estate begins and ends with the purchase of a home and any prospects of investing in office buildings, hotels, and shopping centers seems nearly impossible. However, these investments are more attainable than you may think thanks to real estate investment trusts (REITs).
A REITs sole purpose is to invest in groups of professionally managed properties such as office buildings, apartment complexes, medical complexes, industrial buildings, and so on. REIT performance has varied over the years, but the total annual return for the past 10 years has been 10.5%.
REITs trade like close-end mutual funds. There are a fixed number of shares outstanding and they offer those shares via a price per share model similar to close-end mutual funds. However, unlike close-end mutual funds, REITs gauge performance under different metrics. Rather than measuring performance by net asset value, REITs use a tool called funds from operations. Fund from operations is defined as net income plus depreciations and amortization, excluding gains or losses from debt restructurings and sales of properties. A REITs growth benchmark is a byproduct of funds of operations growth.
Appeal of REITs
REITs offer an array of advantages to investors, including:
Diversification - Investors turn to REITs and their good dividend paying potential for diversification against future market downturns because REITs are uncorrelated with equity markets. Built-in management Each REIT and its property investments are overseen with their own management team, saving investors tremendous time from researching each property's management team. Tax advantages REITs don't pay federal corporate income taxes and are required by law to distribute at least 90% of their annual taxable income as dividends, eliminating double taxation of income. Investors can also have a portion of REIT dividend income be treated as a return of capital. Inflation protection Since landlords are inclined to raise rents more quickly when inflation picks up, equity REITs which obtain most of their income from rents can be an inflation hedge. Weighing out some risks
Just like all investments, REITs carry with them specific risks that you should consider and discuss with your Isakov Planning Group Financial Advisor before adding them to your portfolio. Above all is the lack of industry diversification because all REIT investments include only property investments. Some REITs may be even less diversified when they choose to specialize in specific property developments such as medical buildings, or golf courses. Because of their focus, a REIT investment should be used as part of a diversified portfolio to provide greater diversification.
You should also be aware that REITs are subject to changes in the value of their underlying portfolios, and their prices may fluctuate with changes in their real estate holdings.