Real estate investment trust

Basics
REITs were born from a law that Congress created in 1960 to enable small investors to invest in real estate without the large capital required to purchase single properties, and also without the hassle of property maintenance. When you hold shares of a REIT, you are an actual owner of real estate. REITs receive special treatment under the tax code if the primary purpose of the company is to own real estate and it pays out 95% of its dividend income (rental income) each year to shareholders, the REIT is able to deduct the dividend payments on their corporate income taxes. The special tax treatement they receive means that they are non-qualified dividends for you (ie. not subject to the lower "qualified" dividend tax rate because of double taxation). This makes REITs very tax-inefficient, and best held in tax-deferred accounts. If you have filled up all of your tax-advantaged space with bonds and want to invest in REITs, consider placing them in a Variable Annuity or a Non-deductible Traditional IRA instead of a taxable account. You can also switch taxable bonds in tax-advantaged accounts for REIT in tax-advantaged and Municipal Bonds in taxable accounts.

Types of REITs

 * Equity REITs: REIT stocks traded on a public stock exchange. This makes REITs very liquid unlike owning real estate on your own.
 * Diversified REITs own a diverse group of properties not tied to any specific sector or industry.
 * Industrial REITs own industrial real estate, ie. used for industry manufacturing.
 * Office REITs: REITs that own office buildings or other similar property.
 * Residential REITs: REITs that invest in residential real estate, such as apartment complexes.
 * Retail REITs: REITs that invest primarily in retail properties such as shopping malls.
 * Specialized REITs own property that is specialized in a single use (such as logging or storage).
 * Mortgage REITs: Invest primarily in mortgages backed by commerical real estate, and the earnings are from the mortgage loans. (Vanguard REIT Index Fund does not invest in mortgage REITs since they are not part of the MSCI REIT index).
 * Hybrid REITs: REITs that invest in both property ownership and mortgages.
 * Private REITs: Private REITs are not traded on a public stock exchange, and are very illiquid. These are often sold by financial advisors who receive large commissions not looking out for your best interest, and are meant to be sold and not bought.

Composition of MSCI REIT index
Below is a table of a percentage breakdown of the different types of REITs in the Vanguard REIT Index Fund which tracks the MSCI REIT index.

Interest rate risk
REIT prices may decline as the interest rate rise.

Sector risk
REITs are one specific sector, there are only 97 stocks in the index. This makes REITs more volatile than broad market index funds. Some suggest that public REITs are only a small slice of the commerical real estate market, and best referred to as a separate asset class than a sector.

Role in a portfolio
Most Bogleheads allocate REITs as 5% of the total portfoilo or 10% of equity allocation. REITs should be treated as equity, even though they have income-producing characteristics similar to bonds, due to the risks involved. REITs can act as a portfolio diversifier since they have low correlation to stocks and bonds (either better or worse). REITs are somewhat correlated to inflation, due to the hard asset/rental income nature of the investment, however if you are looking specifically for inflation protection, use TIPS instead. One should consider what Percentages of REITs Present in Vanguard Index Funds they already own before adding a separate REIT fund.

Funds

 * See US Real Estate Investment Trusts for mutual funds and ETFs covering the asset class.


 * Vanguard REIT Index Fund


 * Vanguard REIT Index ETF

Definitions

 * REIT definition on Investopedia
 * Funds From Operations- FFO on Investopedia
 * Timber Investment Management Organization - TIMO on Investopedia

Sites

 * REIT.com
 * REIT Wrecks
 * MSCI REIT Index

Forum Discussions

 * The Core Four is a good forum discussion thread regarding the inclusion of REITs in a portfolio.

Real Estate Research Journals

 * TIAA-CREF Asset Management Research
 * Journal of Real Estate Research
 * Journal of Real Estate Portfolio Management
 * International Real Estate Review

Academic Papers

 * Real estate investing the REIT way by Barclays Global Investor
 * Commercial Real Estate: The Role of Global Listed Real Estate Equities in a Strategic Asset Allocation by Ibbotson
 * Cointegration of Real Estate Stocks and REITs with Common Stocks, Bonds and Consumer Price Inflation - An International Comparison by Westerheide, Peter (2006)
 * The Cross-Section of Expected REIT Returns by Chui, Andy C.W., Titman, Sheridan and Wei, K.C. John (March 3,2003)
 * The Case for REITs in the Mixed-Asset Portfolio in the Short and Long Run by Stephen Lee and Simon Stevenson (2004)
 * The Role of Non-Traditional Real Estate Sectors in REIT Portfolios by Graeme Newell and Hsu Wen Peng (2006)
 * Linkages between Direct and Securitized Real Estate by Oikarinen, Elias, Hoesli, Martin and Serrano Moreno, Camilo, Swiss Finance Institute Research Paper No. 09-26, (June 30, 2009).
 * Commercial Equity Real Estate: A Framework for Analysis by Christopher B. Philips, CFA, Vanguard Investment Counseling & Research, 08/17/2007