REITs produce income through equity, mortgages

While putting money into your home helps to preserve its value, it also requires ongoing capital investments and does not provide a high level of liquidity. There are other investment vehicles available to help you get into the real estate market without the responsibility of being the sole owner of the property. Real estate investment trusts are companies that own a portfolio of real estate to earn cash flow for investors. Commonly known as REITs, these companies usually are publicly traded. You can make a direct investment in a REIT by buying its common shares, just as you would with any other stock.

REITs fall into two basic categories, equity REITs and mortgage REITs.

Equity REITs own real estate. Many of them buy, sell, own, manage, lease and maintain commercial real estate. Portions of the rents received from the properties owned by the REIT – and even capital gains from the sale of buildings – can be a source of income for shareholders who own stock in the REIT.

Mortgage REITs, on the other hand, specialize in lending money to real estate owners, both commercial and residential. Interest income from these mortgages is passed on to investors who own stock in the REIT.

For a better understanding of the advantages of REIT investing, closely examine the way they work. The goal of an equity REIT is to maximize both rental income and income from the portfolio of real estate that it owns, while at the same time minimizing real estate and business expenses, thus generating a positive cash flow.

To maintain REIT status, these companies must pay their investors at least 90 percent of the taxable net income generated by their portfolios in the form of dividends. What’s more, at least 75 percent of a company’s gross income must originate from real estate investments, either in the form of rental income from equity ownership or interest income from mortgages.

Simply stated, a REIT serves as a conduit through which income is passed from a real estate portfolio to shareholders in the form of dividends.

Here are a few tips for successful investing in REITs.

For starters, you want to focus on those companies that have proven management teams. One of the critical factors in the performance of a REIT is a management team that can operate the real estate in its portfolio in such a way as to enhance shareholder value.

In addition, you want to target REITs that have visible, more predictable growth prospects. Companies that have historically delivered developments on time and on budget – and also have a significant pipeline to fund future growth – would fit into this category.

Keep in mind that REITs may be less liquid and contain a higher risk of loss of principal than other forms of publicly traded equity investments. They may be more appropriate for individuals willing to assume a higher degree of risk for the opportunity of potentially greater returns.

Still, REITs can offer an opportunity to invest in the real estate market without having to deal with hands-on operations. Depending on your own risk tolerance and time horizon, among other factors, REITs could be worthy of additional consideration.

If you think you might like to add REITs to your investment portfolio, a financial consultant can help you find specific investments that might be right for you.

Timothy M. Reese is senior vice president-investments with A.G. Edwards & Sons Inc., member SIPC.