Want higher yields? REITs are one alternative

Upward moving arrow on stacks of bills

If you’re looking for a way to earn a decent return and dabble in real estate with few of the downsides of property ownership, a Real Estate Investment Trust, or REIT, might be what you’re looking for.

REITs offer the average investor a way to put money in commercial properties throughout the country.

Ordinarily, investing in real estate can be very expensive after you factor in a large down payment, taking on debt and then managing the property.

But with REITs, you can invest in real estate with as little or as much money as you want.

And you can also invest in things you wouldn’t be able to do otherwise. This includes industrial parks, shopping malls, 2,000-unit apartment communities and medical centers.

These trusts are governed under the IRS tax code, which exempts them from paying corporate taxes but requires them to return 90% of their profits to shareholders.

Real Estate Investment Trusts typically earn income through rent payments and capital gains when they sell a property. As a shareholder, you’re entitled to a small piece of that income each quarter.

According to the National Association of Real Estate Investment Trusts, which tracks more than 129 REITs, the average trust yields 3.35%.

This compares to an average S&P 500 stock yield of 2.6% and an average 5-year CD yield of less than 1%.

These trusts trade on the open market like a stock or mutual fund for a share price that constantly fluctuates. You can buy them from any stockbroker, including the discount online brokerages such as E*Trade and Scottrade.

Also like stocks, you can buy an individual trust or go with a mutual fund or exchange-traded fund that holds a number of REITs.

When you buy a share, you’re essentially buying a small piece of all the properties in the trust.

That share price is driven by supply and demand and what investors are willing to pay to buy or sell it.

As a shareholder, your primary focus should be on the trust's dividends. But you can also earn money through capital gains due to share price appreciation.

In the past couple of years, appreciation has been excellent.

Real Estate Investment Trusts with Solid Returns

Trust Name Trust Holdings Dividend
One Liberty Properties (OLP) Owns and manages a diverse portfolio of 89 retail, industrial, office, flex and health properties, many of which are under long-term leases. 6.48%
Capstead Mortgage Corp. (CMO) An option if you're willing to take on some risk with a mortgage REIT. It owns a leverage portfolio of residential mortgage securities consisting of ARMs issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac. 9.95%
Omega Healthcare Investors (OHI) Invests in income-producing health care facilities. It also provides lease and mortgage financing to operators of skilled nursing facilities, assisted living facilities and rehabilitation and acute care centers. 7.11%
National Retail Properties (NNN) Offers great exposure to the retail industry. It owns 1,422 properties in 47 states with more than 16 million square feet in gross leasable area. 4.91%

A few strong sectors include:

Multifamily homes

These trusts invest in apartment communities and manufactured homes.

The average dividend yield in this sector is roughly 3.10%. It’s comparably low, but misleading because multifamily REIT share prices have seen significant appreciation in the past two years. As the share price appreciates, the yield goes down.

Growth cooled down a bit in 2012, but multifamily had seen tremendous growth in the two years prior due to the crash in the housing market. Home ownership rates have fallen, loans are harder to get and more people are renting.

Analysts say there’s also a pent-up demand for new renters because of high unemployment. When things start to turn around, new leases will be signed, thus putting upward pressure on rents.

Industrial/Office

These REITs build and own industrial properties, warehouses, distribution centers and office buildings. The sector has seen total returns of more than 18% in 2012. Mixed Industrial/Office REITs are yielding near 4.76%.

This sector capitalizes on the growth of industry and business and is highly dependent on GDP and macroeconomic growth.

Retail

Retail trusts invest in shopping centers, malls and other retail parks and properties. Year-to-date growth in the sector has been a whopping 23%, but 10-year returns are still a very impressive 11%. Overall yields are 3.23%.

Analysts say the poor economy has caused a cessation in retail property construction. When it picks up and consumers start spending again, retailers will seek more spaces in malls and shopping centers.

Because there is already a low supply of available properties, that could cause rents to rise, thus increasing revenues for retail REITs.

Health Care

These trusts own hospitals, medical office buildings and assisted living facilities. Of the 11 health care trusts tracked by the National Association of Real Estate Investment Trusts, the average yield is 4.81%.

Analysts say there could be big growth in demand for these facilities as tens of millions of baby boomers hit their golden years.

Heath care REITs also are known to be relatively recession-resistant because this is something people need regardless of how the economy is doing.

Before investing, you should consider the tax implications.

Real Estate Investment Trust dividends derived from rental income (the bulk of your gains) are taxed as ordinary income, meaning you'll pay a tax rate of as much as 35%. Because they escape corporate taxes, the tax burden falls on you.

But sales of properties, which are passed down to you as capital gains, are taxed at a lower 15% rate, although that's scheduled to increase to 20% in 2013.

One other downside: As with any other investment, all real estate trusts come with risk.

Your investment is not FDIC-insured, and you can lose a large portion of it.

This investment product as a whole crashed hard in 2008 when share prices got ahead of themselves and the credit markets dried up.

Just because they're on a roll now doesn’t mean they will be next month or next year. Past performance is never an indicator of future expectations.

But much as with dividend-paying stocks, this is an investment you want to hold on to for at least a few years to ride out the natural market cycles.

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