Abstract: The stock market’s roller coaster ride this year, spurred largely by the COVID-19 crisis, has
many people craving stability. One way to potentially steady a portfolio is
with real estate. This article looks at real estate investment trusts.
Is your
portfolio ready for a REIT?
The stock market’s roller coaster ride this
year, spurred largely by the COVID-19 crisis, has many people craving
stability. If volatility makes you nervous, it’s important to maintain a
diversified portfolio that won’t plummet in value every time the Dow drops. One
way to diversify your portfolio is with real estate.
This doesn’t mean you need to go out and buy several apartment
buildings or commercial properties and become a landlord. There’s an easier,
possibly less risky way, to gain real estate exposure — through a real estate
investment trust (REIT).
Special entities
Although their name might imply it, REITs don’t provide a direct
investment in real estate. Instead, a REIT is a special kind of corporation
that buys, sells and rents real estate on behalf of its investors. To qualify
as a REIT, at least 75% of the company’s income must come from real estate.
Unlike normal corporations, REITs aren’t required to pay taxes at the corporate
level. In exchange for this benefit, they must distribute 90% or more of their
rental income to shareholders in the form of dividends.
These property companies can be either private or publicly traded.
Public REITs are like other public equities in that they trade on stock
exchanges.
Income booster
Investors traditionally have turned to REITs to diversify their
portfolios because they tend to perform differently from bonds and somewhat
differently from the broad equity market, while generating long-term returns
comparable to those of the latter. That said, the correlation between REITs and
U.S. stocks has increased in recent years, which means that REITs may no longer
provide quite the same diversification opportunities as in the past.
Many investors favor REITs for the securities’ relatively large income
stream. Individuals approaching retirement may look to REITs’ dividends as a
source of regular income. (But bear in mind that there’s no guarantee that a
REIT will distribute a dividend.) Liquidity is another important benefit, as
REIT shares can be bought and sold on public markets. What’s more, REITs give
you flexibility to achieve your target real estate exposure because you can own
the exact amount that fits your investment strategy.
There are drawbacks. For example, REIT dividends are taxed as ordinary
income, which is subject to a higher rate than qualified stock dividends. But this
could be mitigated somewhat because 20% of qualified REIT dividends may be
available for the Section 199A qualified business income deduction. One way to
limit REITs’ tax impact is to hold them in an IRA, 401(k) plan or other
tax-advantaged investment account.
Weigh your options
There’s no guarantee that REITs will appreciate or pay dividends. It’s
possible to lose money in such investments. Talk to a qualified investment advisor
about whether a REIT might benefit your portfolio given your personal
circumstances, long-term goals and risk tolerance. We can help you assess the
tax impact.
© 2020