Question: Why do REITs have high dividends?

T. Barnes

Answer:

Dear T. Barnes,

Before discussing REIT dividends, I want to explain what they are for BuyandHolders who may not be familiar with them.

Created by Congress in 1960, REITs (Real Estate Investment Trusts) provide a fairly easy way to participate in commercial real estate without having to get involved in the nitty gritty of ownership - painting, plumbing and papering walls.

Their portfolios

These trusts, whose shares trade on the stock exchanges, are similar to mutual funds -- they pool investors' money to buy, own and/or manage a variety of properties -- or mortgages on properties. Like all stocks, they are subject to market fluctuations and some are high in risk while others are regarded as sound investments.

REITs invest in many types of properties -- apartment houses, strip malls, shopping centers, parking garages, health care facilities, nursing homes, hospitals, rehabilitation institutions, storage facilities, office space and the like.

Some REITs also focus on real estate in a specific geographical area.

The two basic types

• Mortgage REITs combine investors' funds with other borrowed money in order to make loans on real estate. The amount investors actually earn depends on the spread between the interest rates charged on the loans the REIT makes and the interest rates paid on the loans taken out.
  
  
• Equity REITs purchase physical property. The money investors make is based on the rental income and/or appreciation earned by the REIT on its property.

Their tax structure

REITs have a unique tax structure. They avoid corporate taxation at the federal level if 75% of the trust's income is real estate related AND if the REIT pays out 95% of its income to shareholders -- which is done in the form of dividends. This unusual tax situation means, as you've already noted, that REITs tend to have high dividend yields, higher than most (but not all) other types of stocks.

However, as a REIT investor, you must pay tax on your dividend income and upon appreciation if the REIT is sold at a profit.

More information

I recommend that you study the coverage of REITs in Value Line Investment Survey (www.ValueLine.com). This independent research service, updated weekly, analyzes a number of these stocks and will give you an opinion on each -- whether the analyst believes it is a timely or untimely buy, a safe or a risky addition to one's portfolio. If you conclude that a REIT would meet your investment goals, you can purchase a number of REITs here at BUYandHOLD. Our minimum investment is $20.