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 is currently celebrating its 50th anniversary. According to their site: "Over half a century, the U.S. real estate investment trust (REIT) industry has become an important segment of the U.S. economy and investment markets. U.S. REITs have seen their equity market capitalization soar from $90 billion to roughly $200 billion in just the past 10 years. In the process, that growth has set the stage for the adoption of the REIT approach to securitized real estate investment across the globe."
Over time, investors responded to this new opportunity, and listed U.S. REITs today constitute a more than $300 billion equity market with an average daily trading volume of about $4 billion. Unlisted REITs in the U.S. now manage assets of more than $70 billion and are adding another $7 billion annually. Outside the U.S., REITs and listed property companies constitute another $700 billion plus, comprising a listed REIT and real estate investment universe of more than $1 trillion.
You can find a glossary of REIT terms here.
This article was originally published in 2003. It was updated on 11.05.10
