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Investing in real estate through REITs

Richard Loth

For the general public, investing in real estate usually means starting with some form of home ownership and then getting into rental properties. If you take the latter approach, you generally end up risking a lot of money on a few real estate investments, possibly only one to start with. Accompanying this lack of diversification are a number of potential hassles – repairs, maintenance, leasing issues, etc. – that will require attention.If you’re not up to these challenges, there’s an easier way to invest in real estate. Real Estate Investment Trusts, or REITs (rhymes with “beets”), deserve your attention. Adding REITs to an investment portfolio (between 5 to 15 percent of total holdings) provides diversification, above-average dividend income and long-term capital appreciation potential.Background and historyReal estate investment trusts come in three forms – equity, mortgage financing and hybrid. Most REITs are of the equity type that own and operate income-producing real estate properties. REITs have their origin in federal legislation in the 1960s that made investments in large-scale real estate properties accessible to the small investor. It wasn’t until the 1990s, however, when changes in ownership structures allowed real estate companies to become operating companies, that REITs caught the attention of investors.Today, there are 180 real estate investment trusts registered with the Securities & Exchange Commission, with the vast majority listed on the New York Stock Exchange. As measured by their equity market-capitalizations, the most prominent property categories are: retail (26 percent), office/industrial (25 percent), residential (15 percent), mortgage financing (8 percent), and diversified (7 percent).REITs are required by law to distribute each year at least 90 percent of their taxable income in the form of shareholder dividends. The resulting high dividend yields, which are characteristic of REIT stocks, as well as their favorable capital appreciation, have recently propelled REIT stock prices to historical highs. In addition, Institutional Shareholder Services – a corporate responsibility watchdog – in September bestowed their highest ranking for corporate governance on the publicly traded real estate companies. In terms of performance, the listed equity REITs have registered a compound annual total return from 1973 to 2003 of 14.2 percent compared to the Standard & Poor’s 500 Index’s 12.2 percent mark. Last year’s REIT results produced more of the same – the listed equity REITs had a one-year total return of just over 30 percent compared to the S&P 500’s 10.88 percent.A word of cautionMany market observers are raising warning flags over what some consider to be an overheated REIT sector. Investors need to exercise caution in choosing a REIT stock or mutual fund. The Value Line Investment Survey’s Issue # 8 (Jan. 21) profiles the real estate investment trust industry. Of the 18 equity REIT stock reports, which are ranked as conservative, high-quality, dividend paying stocks, I found only three that I consider reasonably priced – New Plan Excel Realty Trust (NXL), Archstone-Smith Trust (ASN), and Weingarten Realty (WRI). The current dividend yields on these three stocks range from 4.6 percent to 6.7 percent.For the less-experienced investor, I would recommend checking out the following highly regarded real estate mutual funds: Vanguard REIT Index (VGSIX), Third Avenue Real Estate Value (TAREX) and Morgan Stanley Institutional U.S. Real Estate (MSUSX).Some exposure to REITs is good for any portfolio. But before you reach for your checkbook, log onto the National Association of Real Estate Investment Trust’s (NAREIT) Web site – http://www.nareit.com – and click on the “Investing in REITs” tab at the top of the home page. There you will find an abundance of easy-to-understand information (see the FAQ list) about REIT investing.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing, an independent registered investment adviser. Loth can be reached at (970) 827-5591 or mentorinvesting@comcast.net.Vail Colorado


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