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What is REIT?
It is probably best if I explain what a REIT is before going any further.
REITs or Real Estate Investment Trusts is a company that buys, develops,
manages and sells real estate assets. REITs allow participants to invest in a
professionally managed portfolio of real estate properties. REITs act as
pass through entities, which basically means that they are designed to pass
profits on to investors through the purchase of income producing rental properties.
Historically, REITs have had there share of ups and downs, both from a tax
perspective and from an investment standpoint. There was actually a time in
their history where you could have been taxed twice for your investment, once
at the corporate level, and then again at the investor level. But that
changed with post W.W.II demand for these types of investments. When
Eisenhower passed the Real Estate Investment Trust tax provision in 1960, the
REIT became a pass through entity. Their popularity increased in the '80s with
the Tax Reform Act of 1986, which allowed REITs to manage their properties
directly. Several years later, pensions were allowed to invest in the income
and appreciation provided by them.
REITs come in three basic flavors: Equity, which invest in and own properties,
collecting rents; Mortgage, which act as lenders collecting interest from
those loans; Hybrids, which are little of both. These companies are often
traded on exchanges, and are a healthy source of income appreciation for not only
pensions, but also insurance companies, bank trusts, and mutual funds.
REITs pay dividends, which not only add to their attractiveness, but also
allow then to shine in their indexes, REITs paid an average of 7.3% over the
last five years of the nineties, which was six times what the Russell 2000
index of small cap stock paid. And therein lies the rub. Many of these
companies qualify as small capitalization concerns, and this makes it
difficult for mutual funds to purchase. A company that is too tiny doesn't
have the liquidity that a large mutual fund would like. But they do provide a
steady stream of income, low volatility, and along with good returns,
they provide stability.
The National Association of Real Estate Trusts reported that mortgage REITs
returned 77.3% total return in 2001. So what about 2002? Many mutual fund
managers have conservatively estimated that the sector will return in the
7-10% range for the year. But that may be just a little too conservative.
The Federal Reserve has cut interest rates 11 times, and if the economy
doesn't start to improve, they may cut them again. If they cut them again and
the equity markets still don't improve the way they did in the fourth quarter
of last year, REITs will literally soar. Numbers as high as 20% in returns
have been tossed out should the recovery take longer than anticipated.
Finding a good fund manager is quite another thing. Many of them avoided the
smallest of the REITs, referring to them as "junk", and because of that, 90%
fell below the benchmark.
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