Commentary: Finance - For diversification and income, seek real

For many investors, real estate investing starts and ends with the purchase of a home. Yet by investing in only one real estate property, you are overlooking the rewards of investing in a multitude of other properties, such as shopping centers, warehouses, office buildings and hotels.

Investing in a hotel or office building may seem overwhelming to many individual investors and has often been viewed as only for the wealthy. However, in 1960, Congress made it easier for the general public to invest in real estate by creating real estate investment trusts. Generally speaking, REITs are publicly traded companies that buy and hold or fund various kinds of housing, retail or commercial properties.

According to the National Association of Real Estate Investment Trusts (www.nareit.com), REITs have outperformed the Dow Jones Industrials, Nasdaq Composite and S&P 500 over the last 30 years, with equity REITs yielding on average more than 12 percent. Despite this fact, REITs are typically underused and widely misunderstood.

How REITs work

There are roughly 180 publicly traded REITs available to investors and they work in much the same way as publicly traded stocks in the major stock exchanges. In the same way that shareholders benefit from owning stock in other corporations, the shareholder of a REIT earns income from the dividends paid by the corporation.

However, unlike other publicly traded companies, REITs are required to pay out at least 90 percent of their taxable income to shareholders in the form of high-yielding dividends, making REITs great income-earning investments. Unfortunately, these dividends are typically taxed as ordinary income and do not qualify for the new, lower tax rates on corporate dividends.

Since these REITs are publicly traded, they also are easily convertible into cash, like other stocks. This offers investors more flexibility and liquidity over investments in individual properties. Like stocks and other investments, REITs can and will fluctuate in value.

Another option for your portfolio is to consider investing in non- traded REITs. Non-traded REITs lack the liquidity of traded REITs as shares cannot be easily or quickly sold. Financial advisors and independent brokers are more likely to recommend non-traded REITs as a long-term investment strategy due to the reduced liquidity. In addition, non-traded REITs have net worth and income level requirements to assure proper suitability for investors.

A professional financial advisor can help you determine which, if either, type of REIT is most appropriate as an investment strategy within your personal economy.

When choosing a REIT for your investment portfolio, it is important to know the different types:

Equity REITs, which invest in actual properties or assets, are the most common. Equity REITs generally offer the highest returns. According to NAREIT, equity REITs had a total return of 11.95 percent over the past 20 years.

Mortgage REITs are corporations that loan money to real estate owners or invest in mortgage-backed securities. Mortgage REITs had an average return of more than 6 percent over the past 20 years. However, over a 10-year period, mortgage REITs returned nearly 11 percent.

Hybrid REITs both own properties and make loans to real estate owners.

Additional benefits

Diversification: Since real estate does not usually move in sync with the bond and stock market, REITs offer investors another way to diversify their portfolios. This diversification may help protect your portfolio from market unpredictability. Many REITs limit diversification within the real estate industry by investing only in niche properties, such as hospitals, or by geographic regions. Investing in more than one REIT or in mutual funds that specialize in REITs gives investors even more diversification and may further limit risk.

Inflation protection: Since landlords often raise rent when inflation rises, equity REITs gain more income and help protect your investments from the long-term corrosive effect of inflation.

Management: Every REIT has its own built-in management team, so investors do not need to research each property's management team.

Although REITs offer numerous valuable benefits, they are not the right choice for every investor. First consider the following factors:

Although high yields are very tempting, immediate high yields can be a warning that the corporation is not reinvesting enough for future property acquisitions or development, which may cut into long- term REIT growth. Likewise, too much company debt also will hamper the growth of your investment.

Do your homework regarding the people behind the product. Before investing in a REIT, make sure that the management has a personal stake in the company. This information should be available in its latest prospectus.

Whether you are considering a publicly traded or non-traded approach, REITs may offer an effective way to augment your portfolio, but like any investment have their pros and cons. To help you determine if either type of REIT is the right choice to help you meet your long- and short-term goals, consult with a qualified financial advisor, who can help you create or update your comprehensive financial plan.

Gary S. Williams is a Certified Financial Planner and senior financial advisor with Williams & Associates, a financial advisory practice of American Express Financial Advisors. He can be reached at 410 740-5885 or toll-free at 1-888-833-9335.

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