REITs are tax advantaged under the IRS regulations if they meet certain tests. Like the Master Limited Partnerships I described yesterday, they are not double taxed. They distribute essentially all of their income to share holders who pay the taxes. The shares of REITs trade on stock exchanges.
A Real Estate Investment Trust invests in a portfolio of real estate properties of various sorts. Some focus on Multi-family Residential or Apartments, some invest in Commercial Properties, some invest in industrial properties, some in warehouses, some in self-storage and some in health care properties. Even with that list, I am probably leaving some out.
The investments fall into two broad categories, mortgage REITs and equity REITS. Mortgage REITs invest in the mortgages on the properties. As debt holders they have priority over stock holders in liquidation. Equity REITs buy the properties directly and either develop and manage them or strictly manage them for existing properties. They have access to increased funding in times of stress by mortgaging their properties. My personal preference is for Equity REITs.
REITs allow you to participate in the ownership of real estate without having to manage the properties yourself. They have low correlation with broad stock market indexes like the S&P 500 so they provide good diversification for your portfolio.
Because REITs distribute essentially all of their income each year, they may be suitable investments for investors who need reliable income each year. Periodically, the share price will fall below the net value of the assets in the REIT allowing you to buy real property at a discount.
Like other investments where a significant proportion of the income comes from dividends, and because real estate performance is tied closely to the cost of mortgages, REITs are sensitive to interest rates and may not be the best investment during times of rising interest rates.
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