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An Explanation of Real Estate Investment Trusts (REITs)

By: , dated January 25th, 2013

You’ve probably noticed that home prices tend to rise over the years. This price appreciation makes them a viable candidate for your investment dollars. This is even more true given that they’re just about the only investment that a person can live in. What this means is that you can derive value from the asset even as it appreciates in value, either by living in it yourself or renting it out to others . Until the last decade or so, this was the primary way to invest in real estate, but a new investment vehicle has grown in popularity in the last several years: real estate securities.

Real-estate securities come in many forms and individual investors can take several different approaches to investing in real estate without actually buying and selling the properties. The most common way is Real Estate Investment Trusts (REITs). A REIT is a corporation or trust that uses the pooled capital of many investors to purchase and manage income property (equity REIT) and/or mortgage loans (mortgage REIT). They generate returns through revenue from leases, mortgages, and selling properties that have appreciated in value. REITs are traded on major exchanges just like stocks. They are also granted special tax considerations, but nearly all the revenues generated must be returned to shareholders in the form of dividends.

REITs offer several benefits over actually owning properties. First, they are highly liquid. In other words, while it’s difficult and time-consuming to buy, rent and sell houses on your own, this isn’t the case with REITs, which can be bought and sold as easily as stocks. Second, REITs enable you to own a share in non-residential properties as well, such as hotels, malls, and other commercial or industrial properties. Third, there’s no minimum investment with REITs: you can start as small as you want; this isn’t the case with actually buying a house.

REITs do not necessarily increase and decrease in value along with the broader market. However, because they also pay yields in the form of dividends no matter how the shares perform, they are considered fairly safe investments. REITs can be valued based upon fundamental measures, similar to the valuation of stocks, but different numbers tend to be important. Funds From Operations (FFO) tends to be a good metric because it eliminates many of the complications that cloud the indications presented by net income or more traditional measures of performance. FFO is calculated by taking net income and removing the effects of debt restructuring, one-time charges, property sales, depreciation and amortization. The holdings and transactions of REITs should also be studied to determine diversification and aggressiveness, as REITs can have a wide variety of investment styles and objectives.

Equity REITs draw earnings from rent on properties that they own as well as capital gains from selling those properties. Mortgage REITs take a different approach by lending money to developers instead of amassing a group of properties. Earnings, therefore, are derived from interest. Hybrid REITs invest in both property and mortgages and draw earnings from rent, capital gains and interest.

If you ever wanted to invest in real estate but didn’t want to go through the hassle of finding the right house, buying it, renting it out, and later selling it, you might want to consider including REITs in your portfolio.

This article was brought to you by the InvestorGuide Staff Writers and Editors.

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