Real Estate Investment Trust (REIT) is a type of corporation that invests in real estate, and is jointly owned by a number of shareholders. Typically, you can buy a share in a REIT from the stock market, which makes them just like mutual funds; but they are more like a fund that invests only in real estate.
Two types of REITs – Equity and Mortgage REITs
Real Estate Investment Trusts can buy two types of properties in the domain of real estate. One is real estate itself, and another is mortgages for real estate. In the former case, the REIT is called Equity REIT, and in the latter case the REIT is called Mortgage REIT. Mortgage REITs in effect act like a lender, and allow borrowers to buy money in the form of mortgages. Their principle source of income, in turn, is from the interest paid for such mortgages. In the case of Equity REITs, the principle source of their income is generated by rent and appreciation of the prices of the properties owned by them.
It should be remembered that real estate prices are always very dependent on the prevalent interest rates in the economy, so every REIT is affected whenever the interest rates rise or fall. However, mortgage REITs are even more sensitive towards interest rates than equity REITs, because if interest rates change a lot then their customers may find it difficult to pay back their mortgages and default on them. Thus, one should know about the risks involved in investing in different types of REITs before making a decision to invest in them.
There is another type of REIT called a hybrid REIT, which, as the name suggests, invests in both real estate and mortgages. Such REITs allow you to diversify your investment.
Advantages of REITs
The most obvious advantage of REIT’s, and their raison d’être, is that they allow the average investor to invest in real estate without having to invest hundreds of thousands of dollars. By buying a share in a REIT, you are a partial owner of a real estate property through that REIT. As is widely known, real estate is a very wise choice as an investment asset, and by investing in REIT, you can include real estate in your investment portfolio easily.
Another advantage of REIT is that they have some inherent tax benefits under the US tax laws, such as the fact that they do not have to pay a tax as a corporation as long as they continue to disburse 90% of their income to their shareholders.
REIT’s are for investors who want a stable source of income that does not come with too much risk. REIT’s can easily beat bond yields for long periods of time, which makes them an attractive proposition for the conservative investor.
In summary, we find that REIT’s are an unusual kind of asset vehicle – they allow their shareholders to own real estate when the shareholder many not have the capability to invest in real estate directly. This allows them to diversify their portfolio, which otherwise may only contain stocks or precious metals, and other kinds of assets.