Public and Private Real Estate Investment Trusts

Real estate investment trusts (REITs) are for-profit companies that own and generally operate different types of property. The options for REIT investments are extremely broad and cover virtually every type of real estate. You can choose your favorite REIT from the following property types:

• Office: Ranging from Class “A” urban skyscrapers to single-story or low-rise suburban Class “C” buildings
• Residential: Apartments, student housing, manufactured homes, single-family homes
• Retail: Regional malls, outlet centers, grocery-anchored shopping centers
• Industrial: Warehouses, distribution centers
• Lodging: Hotels, resorts
• Healthcare: Hospitals, medical/dental office buildings, senior living facilities, skilled nursing and memory care facilities
• Self-storage
• Cell towers
• Other rental income properties, even timberlands

These property-holding REITs (see the following figure) are known as equity REITs. Some REITs, known as mortgage REITs (or mREITs), focus on the financing end of the business; they lend to real estate property owners and operators or provide credit indirectly through buying loans (mortgage-backed securities).

Equity REIT managers typically identify and negotiate the purchase of properties that they believe are good investments and manage these properties directly or through an affiliated advisory and management company, including all tenant relations. Thus, REITs can be a good way to invest in real estate for people who don’t want the hassles and headaches that come with directly owning and managing rental property. You can also invest in different property type REITs to diversify your portfolio, but check their returns and expense ratios as not all REITs within the same property type field are equivalent. This is similar to the reality that while most mutual funds all invest in the same pool of NYSE listed stocks, not all have the same expenses or results.

We recommend that investors not be shy about asking for full disclosure of the relationship between the REIT, its advisors, and the management companies. REITs often involve conflicts of interest that aren’t clearly disclosed or pay significant above-market fees to directly or indirectly related entities or affiliates that ultimately lower the cash flow and return on investment available for distribution.

Public REITs are traded on the major stock exchanges and thus must meet strict SEC reporting requirements:

• Liquidity: Public REITs trade every business day on a stock exchange and thus offer investors the ability to buy and sell as they please. Of course, as with other similarly liquid investments (like stock in companies in a variety of industries), liquidity can have its downside. More-liquid real estate investments like REITs may inspire frequent trades caused by making emotional decisions or trying to time market movements.
• Independent board of directors: A public company must have directors, the majority of whom are independent of its management. Shareholders vote upon and elect these directors, but that is no guarantee of their competency.
• Financial reporting: Public REITs, like other public companies, must file comprehensive financial reports quarterly.

We recommend that you stay away from private REITs unless you’re a sophisticated, experienced real estate investor willing to do plenty of extra research and digging. Because they’re not publicly traded, private REITs don’t have the same disclosure requirements as public REITs. This difference means an investor in a private REIT had better carefully scrutinize the prospectus and realize that the private REIT has the ability to make changes that may not be in the investor’s best interests but that reward the private REIT sponsors or their affiliates. Ask what commission is deducted from your gross investment to arrive at your net investment. You may be surprised at the “acceptable commission rates” for private REIT investments, especially when you compare your experience with most mutual funds with very low competitive fees and no commissions with no-load funds.

Take a look at REIT performance

So, what about performance? Over the long term, REITs have produced total returns comparable to stocks in general. In fact, REIT returns historically have been as good as or better than stock returns, whereas REITs have also generally been less volatile than stocks. In the context of an overall investment portfolio, REITs add diversification because their values don’t always move in tandem with other investments.

One final attribute of REITs we want to highlight is the fairly substantial dividends that REITs usually pay. Because these dividends are generally fully taxable (and thus not subject to the lower stock dividend tax rate), you should generally avoid holding REITs outside of retirement accounts if you’re in a high tax bracket (for instance, during your working years).

Investing in REIT funds

You can research and purchase shares in individual REITs, which trade as securities on the major stock exchanges. An even better approach is to buy a mutual fund or exchange-traded fund that invests in a diversified mixture of REITs. Some of the best REIT mutual funds charge 1 percent per year or less in management fees, have long-term track records of success while taking modest risks. Vanguard’s Real Estate Index Fund charges just 0.12 percent per year in fees and has produced average annual returns of about 10.2 percent since its inception in 1996.

Vanguard also offers a REIT ETF (exchange-traded fund) through most discount brokers and boasts a low management fee of 0.12 percent. (You can buy it without any brokerage fees through Vanguard.)

In addition to providing you with a diversified, low-hassle real estate investment, REITs offer an additional advantage that traditional rental real estate doesn’t. You can easily invest in REITs through a retirement account such as an IRA or Keogh. As with traditional real estate investments, you can even buy REITs and mutual fund REITs with borrowed money (in nonretirement accounts). Although risky, you can buy with 50 percent down, known as buying on margin, when you purchase such investments through a brokerage account.

The following contains a short list of the best REIT mutual funds and ETFs currently available.

If you really have your heart set on becoming the next Warren Buffett and you enjoy the challenge of selecting your own stocks, you can research and choose your own REITs to invest in. Both of the investment research publications Morningstar and Value Line, which can be found at many local libraries as well as online, produce individual stock page summaries on various REITs. In addition to having a professional manager deciding what REITs to buy and when, the mutual fund REITs listed in the table also provide consolidated financial reporting. If you purchase individual REITs, you have to deal with tax statements for each and every REIT you’re invested in.