Tuesday, May 12, 2009

Taking the Pain Out of Real Estate Investing With REITs

by John Jagerson

Investing in real estate has been a strategy that falls in and out of favor depending on what the general economy is doing.

In 2008-2009, real estate investors took a hard hit with prices dropping significantly, but now that the economy seems to be flattening, real estate bargain hunters are beginning to reemerge.

This article will discuss how a savvy investor can include some exposure to the real estate market within their portfolio without all the headaches.

Real estate investors are drawn to the market because of the perceived potential for large returns. However, what many investors don't understand is that the unusually large returns in a strong economy are due to the use of leverage through loans.

Because of the high cost of real estate, excessive leverage is one of the only ways most individual investors can participate in the market, but it comes with significant and often unanticipated risks.

Excessive leverage in a fairly illiquid asset like real estate can become an account killer quickly. This is the situation so many investors find themselves in now. Leverage has left them upside down on their losses and, in many cases, has wiped out years of profits.

The stock market offers opportunities to invest in real estate, including the possibility of large profits without the usual problems. This can be done through Real Estate Investment Trusts (REITs) that are publicly listed as a stock and available to almost any investor.

A REIT invests in real estate and then sells shares of ownership in the trust on the public market. When you buy a share of a REIT, you are buying partial interest in a real estate investment. This allows you to buy real estate without having to use leverage.

Many REITs are specialized in a specific kind of real estate like Plum Creak Timber (PCL) that invests in land used for lumber production.

Through REITs you can own a share of stores, commercial properties, residential neighborhoods or other income properties that would otherwise be inaccessible to most individual investors.

If investing in a single REIT or real estate strategy doesn't offer the level of diversification you desire, then you may want to consider REIT exchange-traded funds (ETFs). (Learn more about investing in ETFs.)

These ETFs pool investments in many REITs so that diversification can be improved. The iShares FTSE NAREIT Industrial/Office index (FIO) (commercial property) and the iShares FTSE NAREIT Residential index (REZ) (residential property) are good examples of these kinds of ETFs.

An ETF or REIT adds the advantages of liquidity, low entry prices and transparency to the possibilities of profits.

REITs are usually (but not always) negatively correlated with stocks, which helps to smooth your portfolio's growth over the long term. While REITs can experience share price growth, most profits come from dividends that can reach 10% or more. This makes them an interesting addition to tax-sheltered accounts held over the long term.

When compared to the management requirements, financing hurdles, liability and liquidity issues of a real estate investment, REITs present an attractive alternative.

Good investing, Kingsley.

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