What Are They?
- Real Estate Investment Trusts, knows as "REITs", are publicly traded companies that purchase and manage income generating properties such as offices, apartments or shopping malls (equity REITs) or mortgage loans (mortgage REITs).
- US REITs are classified for tax purposes as pass-through entities, meaning that they are free from tax at the corporate level. To be classified as a REIT, a real estate company must pay out at least 90% of its taxable income to its shareholders in the form of dividends. Individuals are then taxed on those dividends as normal income, not at the lower rate for stock dividends. (Check this with your accountant.)
- REIT ETFs are tradeable index funds that hold REIT stocks. Because REITs must pay out at least 90% of their taxable income as dividends, REIT ETFs tend to generate higher dividend yields than other ETFs and are often classified as "dividend paying ETFs".
Why & How To Use Them
- REITs are a distinct asset class to stocks and bonds, and offer exposure to real estate without the hassle of directly owning and managing property. REIT ETFs therefore provide added diversification to a portofolio.
- REIT ETFs can also be used to hedge exposure to the real estate market. Individuals who want to purchase property in the future can try to hedge against price rises by purchasing REIT ETFs, and individuals planning to sell property in the future can try to hedge against price declines by selling short REIT ETFs.
- Residential REIT ETFs are also a tool for speculation on house prices. Some people who believe the housing market is in a bubble have advocated selling short residential REIT ETFs.
What to Look Out For
- Some people think that REIT ETFs can be used to hedge property prices. But REITs own portfolios of properties that may differ significantly from property owned by individuals, so trying to hedge your house price by shorting a residential REIT ETF may fail. And homebuilder ETFs may be better correlated to house prices.
- Because REITs pay hefty dividends, shorting REIT ETFs may be expensive, as the short seller is obligated to pay the dividends.
- The broad REIT indexes tend to be dominated by commercial real estate REITs, such as those owning offices and malls.
- Discussion of the international REIT ETFs: Warming Up To International Real Estate Funds (Roger Nusbaum), And Then There Were Two: WisdomTree Launches International REIT ETF (Matt Hougan), BGI's New International REIT ETF Is Heavy On Japan (Matt Hougan).
- Discussion of the broad US index REITs: REIT ETFs - Comparative Analysis (Where is the Yield?), Choosing a Real Estate ETF (Keith Lenger), and Comparing the Cost of Real Estate ETFs (David Jackson).
- Discussion of the REIT sub-sectors: Timing the Real Estate Market With iShares' New Sector REITs (Matt Hougan).
- For discussion of REIT ETFs and their relationship to house prices, see: Looking To Short Real Estate Via ETFs, REITs vs. Homebuilders - Not What You Think (Roger Nusbaum), and Investing in Real Estate: REITs and Your Home (Geoff Considine). As a hedge against house prices, consider also homebuilder ETFs.
- For long term investors considering REIT ETFs for inclusion in a diversified portfolio: An All-Weather Portfolio Using Multiple Asset Classes (Chris Ciovacco), Portfolio Mix: Where Do REITs Fit In? (Roger Nusbaum), and ETF Investing Guide: A Core ETF Portfolio (David Jackson).
This page is part of The Seeking Alpha ETF Selector which sorts ETFs by type, highlights how to use them and what to look out for, and provides links to articles that discuss key issues for investors.