8 things investors should know about REITs

Here’s a look at eight things investors should know before they invest in real estate investment trusts:

1. REITs defined: REITs are companies that own income-producing real estate, and in most cases manage it as well. Shares of the companies are traded, just like stocks, on exchanges.

2. Special tax status: Unlike other companies, a REIT is permitted to deduct dividends paid to its shareholders from its corporate taxable income. Taxes are paid by shareholders on the dividends received, and any gains from a rise in the REIT’s stock price. To maintain their special status, REITs are required to distribute at least 90 percent of their taxable income to shareholders each year. Traditionally, those distributions have been made as dividends. However, in 2008, the IRS gave REITs a new option. They can meet the requirement mostly by giving investors new shares of stock, rather than paying out only in cash.

3. History: Congress created REITs in 1960 so average investors could invest in commercial real estate the same way they invest in other industries by purchasing stock. In 2001, REIT stocks first appeared in the Standard & Poor’s 500 index. Today, REITs own about $500 billion in commercial real estate, or more than 10 percent of all commercial properties. They paid out about $18 billion in dividends last year.

4. Number: More than 150 REIT stocks trade on major stock exchanges. They have a combined market value of about $460 billion.

5. Index: The best-known measure of REIT performance is the FTSE NAREIT All REITs index. It measures the performance of 160 REIT stocks.

6. Traded vs. untraded: Most REITs are publicly traded on major stock exchanges. Others aren’t traded, although individuals can still invest in them. Many of these REITs restrict investors from withdrawing invested cash for a specified period, typically several years. After a liquidation date, investors receive proceeds from any profits the REIT earns from property value appreciation. Losses are possible.

7. Equity vs. mortgage REITs: Equity REITs own properties such as apartments, shopping centers, offices and warehouses. Mortgage REITs are far less numerous. They primarily lend money to real estate owners and operators, or invest in mortgage-backed securities — loans which are bundled together and sold to investors.

8. Financial performance: The most commonly used measure of corporate financial performance is net income, or profits. REITs use an additional measure called Funds From Operations, or FFO. It’s intended to provide a more accurate picture of a REIT’s cash performance by excluding gains or losses from most property sales. Depreciation in the value of real estate is also excluded.

Source: National Association of Real Estate Investment Trusts