REITS

This week’s blog is about Real Estate Investment Trust (REIT). I have never invested in a REIT; but it would be a good investment vehicle for dividends (which historically have been 4x the S&P 500 dividend returns), liquidity (vs. owning individual real estate), diversification and as an inflation hedge. As is the case of any equity investment the total return is comprised of share appreciation and dividend income return. For example, if the dividend return is 10% per year, in a little over 7 years you would have returned the purchase price of the stock (rule of 72). In portfolio theory the more diversified you are the lower your overall portfolio risk. Over the last 20 years REITs have had very strong diversification correlation to the Standard and Poor (S&P) 500 (please see the following for more information: http://www.reit.com/InstitutionalInvestors/Diversification.aspx). REITs can also be inflation hedges based on historic data; the dividend growth rate has exceeded the CPI index from 1992 to 2008. When you own individual real estate you have an unliquid investment. REITs makes the owning of real estate a liquid investment (especially publicly trade REITs).

In the US REITs are required by law to distribute 90% of their income to investors (they are like Canada trusts). A lot of REITs will pay out 100% of their income to investors. REITs are designed to provide structure for real estate similar to what mutual funds provide for stocks. A REIT cannot pass any tax losses through to its investors. REITs must adhere to a number of rules, for example, there must be more than 100 investors and no investor can own more than 5% of the REIT.

There are 2 major types of REITs. The most common own and operate income producing real estate. Examples of equity REITs that own real estate are the following:

· Industrial and office space
· Retail (standalone and malls)
· Residential (i.e. apartment complexes)
· Lodging and resorts
· Health care
· Self storage
· Timber (or other ‘real’ assets)

The second type engages in real estate financing, for example, mortgages for industrial and office buildings.

REITs can be publicly and non-exchange traded and private trust. The following URL compares them: http://www.reit.com/AboutREITs/~/media/Portals/0/PDF/2009%20REITTypesNewCovers.ashx
. Public traded REITs work the same as stocks. You buy and sell shares just like any publicly traded company. Most of the publicly traded REITs are listed on the New York stock exchange. Just like other publicly traded companies, shareholders have no liability for debts of the REIT. The US market capitalization is over $250 billion and there are approximately 140 publicly traded REITs.

For US tax purposes REIT dividends are allocated to ordinary income, qualified dividends, capital gains and return of capital. This information is distributed to each shareholder by the IRS 1099-DIV form. If the REIT is in a non-taxable account (for example IRA, ROTH, 401K, etc.) you will pay no taxes. If it is in a taxable account the following are the tax consequences of REITs:

· Since the REITs in most cases do not pay corporate taxes (they need to distribute at least 90% of their income to shareholders) the majority of dividends will be taxed at your income tax bracket. For example, if your income tax bracket is 35% your dividend tax rate will be 35%.

If the REIT distributes qualified dividends the tax rate will be 15% for most taxpayers (it can be 10% for lower income earners). This may change in 2011 (see my previous blog).

· If the REIT distributes return of capital you will not pay taxes on the amount that was returned capital. The cost base of the REIT is reduced by the returned capital. For example, if you bought the stock for $25 and the returned capital is $1 per share the new cost base is $24.

· The REIT can also generate long term capital gain. For most taxpayers the tax rate is 15% (it can be 0% for lower income earners). This may change in 2011 (see the previous blog).

If you are interested in REITs’ historical 1099-DIV returns please check the following URL: http://reit.com/IndustryDataPerformance/Year-EndTaxReportingData/Historical1099Data1995-2008/

The following are examples of publicly traded REITs, by type and marketing capitalization that are included in the S&P 500:

· AIMCO (AIV) – Apartment investment and management company ($2.3 billion)

· Health Care REIT Inc. (HCN) – Buys and manages health care properties ($5.41 billion)

· Public Storage, Inc (PSA) – Involved in the acquisition, development, ownership, and operation of self-storage facilities in the United States and Europe ($31.37 billion)

· Ventas, Inc. (VTR) - Buys and manage health care related and senior housing properties ($7.54 billion)

In a future blog I will be writing about when you may want to buy publicly and non-publicly traded REITs and what REIT type and sector (i.e. retail, public storage, etc.).

Please chime in with comments about REITs, economic forecast for types of REITs (for office building, retail, medical, etc.), REITs to buy or short, etc.

© 2010 Paul Cusick

Paul