REAL ESTATE investment trusts come in two basic flavors. Mortgage REITs earn interest by providing financing to real estate owners and operators. Equity REITs purchase and operate properties such as apartment buildings, shopping centers, warehouses and office buildings. They collect rent and other income, which is then passed along to shareholders, and also occasionally make money by selling properties at a profit. Equity REITs account for 90% of REIT assets.
Equity REITs lagged behind the broad U.S. stock market in the 1990s, but were strong performers in the 2000s, with the exception of 2007 and 2008. Recent years, however, have been mixed. As of January 2020, the stocks in FTSE NAREIT’s all equity REIT index were yielding 3.6%, up from 3.1% in April 2013 but below the 10.1% peak hit during the selling frenzy of February 2009. Investors’ appetite for REITs is heavily driven by interest rates.
REITs must distribute at least 90% of their taxable income to shareholders each year. Those dividends can be deducted against a REIT’s taxable income, so most REITs pay no corporate income taxes. Because of this favorable tax treatment at the corporate level, the dividends paid to REIT shareholders don’t qualify to be taxed at the long-term capital gains rate. Instead, they’re taxed as ordinary income. Because of that tax treatment and because REITs kick off so much income each year, you should probably hold your REITs in a retirement account.
Most major mutual fund companies, as well as the big ETF providers, now offer funds that invest in REITs. There are also many closed-end funds focused on real estate. For more on REITs, check out the website REIT.com/investing.
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