History suggests that the home you live in is likely to be the largest investment you will ever make. But because the costs and barriers to get into the real estate market are so high, many investors look no further than their front door.
But as Phil DeMuth of Conservative Wealth Management explains in this installment of Investing 101, REITs (or Real Estate Investment Trusts) make it possible to buy properties you couldn't even dream of owning yourself.
1) What Exactly Is a REIT?
"A Real Estate Investment Trust is a business that buys real estate. Typically they specialize in one particular slice of the commercial market," he explains, pointing out that a REIT buys a series of properties, manages them, collect rents, and then passes that money along to shareholders.
Here's how REIT.com explains their purpose:
"They were created by Congress in 1960 to give all Americans – not just the affluent – the opportunity to invest in income-producing real estate in a manner similar to how many Americans invest in stocks and bonds through mutual funds."
2) What Kind of Real Estate Do REITs Own?
If you can build it, chances are there's a REIT that owns it. This includes such diverse offerings as apartments, shopping malls, storage facilities, hotels, nursing homes, office space, hotels, industrial parks and even prisons. In fact, DeMuth says, one of the newer additions, this year, to the stable of offerings, is residential real estate or single family homes. It allows investors to partake in a timely trend, without forking out tens of thousands of dollars.
"People who have been priced-out of the housing market," he says "can still participate in the residential market by buying one of these REITs."
One such new offering is American Residential Properties (ARPI), which just came public in May.
3) How and Where Do You Buy a REIT?
Today, there are more than 160 different REITs traded on the New York Stock Exchange worth an estimated $650 billion, REIT.com says. They control more than a trillion dollars worth of real estate. Instead of picking them one-by-one, DeMuth thinks most people would be better off owning a passive index fund, that tracks the entire sector.
"The ordinary investor should not get involved in trying to pick if hotels are going to do better than shopping malls this quarter," he says, adding that the benefits, reduced costs, and "one mouse click" simplicity of owning REITs is hard to beat.
4) Is it a Good Time to Buy REITs?
Since 2009, DeMuth points out, real estate is the single best performing asset class, gaining almost 200%.
"It has been very hot, so you have to be aware that while it has momentum on its side, the valuations have also gotten very high." He recommends "nibbling" rather than diving in, and using real state "in a supporting role capacity."
5) What Are The Risks?
Like any investment, the value of REITs will fluctuate, and the price can go up or down. In fact, during the recent implosion of the bond market, when 10-year Treasury rates went from 1.6 to 2.7%, the most-watched REIT Index (^MVR) fell 17%.
He also says, if possible, that it is an advatage to own REITs within a tax-sheltered investment account, like an IRA, because much of the income that REITs pass along is taxed as regular income, not dividends.