The Advantages of Real Estate Investment Trusts (REITs) for Individual Retirement Accounts (IRAs)
Although some publicly traded Real Estate Investment Trusts invest in mortgages or other assets, most are equity REITs: corporations or trusts that own and operate real estate properties that generate income that is paid to investors.
The primary attraction is that publicly traded REITs are much more liquid than direct purchases of real estate and may be held in any IRA that allows the purchase of shares of stock.
Equity REITs also hold hard assets that may act as an inflation hedge and produce capital gains when sold. In addition, they are required to pay out all, or almost all, of their otherwise-taxable income as dividends to shareholders.
Including REITs in your retirement planning increases diversification and may reduce overall risk and volatility in the value of your IRA while increasing your returns.
The Basics of Real Estate Investment Trusts (REITs)
There are well over 120 publicly traded REITs in the United States. Many other countries such as Canada, Australia, and the United Kingdom have REITs or similarly-structured investments and others are in the process of creating the legal framework for them. In particular, Mexico has recently revised its tax laws to encourage the creation of FIBRAs, that country’s version of REITs.
The largest sectors for equity REITs are retail malls and shopping centers, offices, apartments, and health care facilities. However, there are REITs that invest in everything from mobile home communities to self-storage centers and from hotels to warehouses. Most REITs are geographically diversified and some even hold real estate properties in different countries.
Many REITs also issue preferred stock, which has characteristics of both stocks and bonds. These shares are also worth considering for IRAs because they often pay high dividends, especially when calculated against purchase prices well below par value as often seen during times of economic distress. There are advantages and disadvantages of this hybrid instrument that should be researched by investors.
Besides investments in individual REITs, there are also publicly traded vehicles such as exchange-traded funds, closed-end funds, and mutual funds that hold multiple REITs and offer the advantage of further diversification within the field of REITs but at the cost of another layer of administrative fees. These funds may be especially appropriate for less active investors because of the further oversight by the fund of the professional real estate managers of the REITs they hold.
The Real Estate Cycle Creates Investing Opportunities
In the slowing economic climate of 2008-2010, property values in general decreased and funds from real estate operations usually either decreased or even turned into losses, pushing down the value of the REITs themselves. Most REITs also rely on the availability of loans for purchase of property as a means of leveraging their capital. The problems in the financial markets made it harder to obtain loans and increased the costs associated with them. Since most REITs produced less taxable income, or even tax losses, they either reduced their dividends or eliminated them entirely, further depressing share prices.
So the current economic downturn may be creating an attractive opportunity for those willing to do their research and purchase particular REITs which may provide handsome returns in the future. Although share prices in many instances have risen from their lows, there are still many REITs available at relatively low values that may eventually turn profitable and begin paying or increasing their dividends and generating increased market value which holds the possibility of capital gains.
There will eventually be another general down cycle in the real estate market or down cycles in particular real estate sectors, either of which which would create better buying opportunities for investors. It may happen sooner or later but happen it will. As Warren Buffett advises, be greedy when others are fearful and be fearful when others are greedy.
The Advantages of Individual Retirement Accounts (IRAs) for Investing in Real Estate Investment Trusts (REITs)
An Individual Retirement Account (IRA) is the ideal type of account to hold REITs because the dividends and capital gains grow tax free. Depending on the type of IRA, taxes are paid on contributions and withdrawals are tax-free or else the contributions are deductible and the taxes are deferred until funds are withdrawn from the account. Decisions about whether or not to purchase investments that produce high current income or when to sell shares and take capital gains can be made without considering the immediate tax consequences when the decisions are made within the context of an IRA.
Learning More about REITs
Real estate is a core investment class along with stocks, bonds, commodities, and cash, yet many people overlook it completely. REITs are a good way to diversify an IRA into another liquid asset class, which may reduce risk and increase returns over the long run.
A good place to learn more about REITs is from the National Association of Real Estate Investment Trusts. Their website at www.reit.com provides a lot of reliable information and even offers subscriptions to publications at no charge to investors.
This article is intended only to provide basic introductory information and extend the range of investment possibilities under your general consideration. Always do your own research, especially regarding risk. Seek specific financial, legal, and tax advice from qualified professionals before making investments.