Adding Real Estate to Your Portfolio
Have you ever considered investing in an income-producing real estate property such as a rental house or apartment building? It might seem like a good idea, but this type of investment typically requires substantial capital. Even if you have the necessary cash or credit, you may not want the responsibility that comes with being a landlord.
There is another way to invest in the real estate market and gain exposure to a wide variety of properties and locations. Exchange-traded real estate investment trusts (REITs) enable individual investors to buy shares of income-producing real estate in a manner similar to purchasing stocks and bonds. Almost 40 million Americans invest in REITs through pension and retirement plans, and many others invest outside of such plans.1
A REIT is a type of real estate company that combines capital from investors to purchase and manage properties that could range from shopping malls, apartment buildings, and medical facilities to self-storage facilities, hotels, cell towers, and timberlands. This type of REIT, which derives most of its income from rents, is called an equity REIT. There are also a number of mortgage REITs that derive most of their income from interest on mortgage loans.
Income and Diversification
Under the federal tax code, a qualified REIT must pay at least 90% of its taxable income each year in the form of shareholder dividends. Unlike many companies, REITs generally do not retain earnings and may provide a reliable income stream regardless of the price performance of their shares. This has attracted investors looking for higher yields than might be obtained from stocks or bonds.2
REIT share prices do not necessarily rise and fall with the stock market, so they may help provide portfolio balance and an alternative opportunity for potential growth (see chart). Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
REIT distributions are taxable to the extent they include any ordinary income or capital gains. Some REITs might not qualify as a REIT as defined in the tax code, which could affect operations and negatively affect their ability to make distributions.
The return and principal value of all stocks, including REIT shares, fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. There are inherent risks associated with real estate investments and the real estate industry that could adversely affect the financial performance and value of a real estate investment. Some of these risks include a deterioration in national, regional, and local economies; tenant defaults; local real estate conditions, such as an oversupply of, or a reduction in demand for, rental space; property mismanagement; changes in operating costs and expenses, including increasing insurance costs, energy prices, real estate taxes, and the costs of compliance with laws, regulations, and government policies.
Real estate investments may not be appropriate for all investors, so be sure to do your research before investing. Depending on your risk tolerance and long-term goals, a REIT might play an important role in your portfolio.