Subject: Real Estate - Investment Trusts (REITs)
Last-Revised: 8 Dec 1995
Contributed-By: Braden Glett (glett at prodigy.net)
A Real Estate Investment Trust (REIT) is a company that invests its assets in real estate holdings. You get a share of the earnings, depreciation, etc. from the portfolio of real estate holdings that the REIT owns. Thus, you get many of the same benefits of being a landlord without too many of the hassles. You also have a much more liquid investment than you do when directly investing in real estate. The downsides are that you have no control over when the company will sell its holdings or how it will manage them, like you would have if you owned an apartment building on your own.
Essentially, REITs are the same as stocks, only the business they are engaged in is different than what is commonly referred to as "stocks" by most folks. Common stocks are ownership shares generally in manufacturing or service businesses. REITs shares on the other hand are the same, just engaged in the holding of an asset for rental, rather than producing a manufactured product. In both cases, though, the shareholder is paid what is left over after business expenses, interest/principal, and preferred shareholders' dividends are paid. Common stockholders are always last in line, and their earnings are highly variable because of this. Also, because their returns are so unpredictable, common shareholders demand a higher expected rate of return than lenders (bondholders). This is why equity financing is the highest-cost form of financing for any corporation, whether the corporation be a REIT or mfg firm.
An interesting thing about REITs is that they are probably the best inflation hedge around. Far better than gold stocks, which give almost no return over long periods of time. Most of them yield 7-10% dividend yield. However, they almost always lack the potential for tremendous price appreciation (and depreciation) that you get with most common stocks. There are exceptions, of course, but they are few and far between.
If you invest in them, pick several REITs instead of one. They are subject to ineptitude on the part of management just like any company's stock, so diversification is important. However, they are a rather conservative investment, with long-term returns lower than common stocks of other industries. This is because rental revenues do net usually vary as much as revenues at a mfg or service firm.
REITNet, a full-service real estate information site, offers a comprehensive guide to Real Estate Investment Trusts.