REITs

Investing in real estate can be risky and difficult. Buying a property usually requires a large down payment, it takes a long time to buy and sell, and it's about the least diversified investment imaginable.

If you're interested in investing in the real estate market, but put off by these concerns, you might be interested in REITs!

A REIT (say “reet”!) is a Real Estate Investment Trust. It's a bit like a mutual fund. A company involved in real estate sells shares of its business. Since the company owns many properties, your investment is more diversified. And since shares of REITs can be traded as easily as stocks and bonds, con can invest without a big lump sum and cash out whenever you'd like.

There are many REITs. Some focus on a particular area (e.g., Atlanta), and some focus on a particular segment of the market (like small commercial properties). This is convenient, since you can pick the REITs that reflect your beliefs about how specific slices of the real estate market will behave. This is awfully similar to stock picking, though, and a diverse portfolio is a safe portfolio, so I'd advise you not to be invest too specifically unless you've really done your homework.

Like bonds, REITs usually pay out dividends. And as we saw when we discussed bonds, dividends are taxed immediately in a way that capital gains from stocks, for instance, aren't. It's a good idea to keep your REITs, along with your bonds, in a tax-advantaged account.

REITs have some downsides. The performance of the national housing market in particular (and the real estate market in general) correlates somewhat with the stock market, so I'm not convinced that holding REITs significantly diversifies your portfolio. Furthermore, the average historic returns on REITs are a bit less than you'd get on an index fund. For these reasons, I don't currently hold any REITs.

Because they pay out fairly regular dividends, though, REITs may be increasingly useful as you approach retirement. You'll be more interested in creating a stable stream of income, and less concerned with maximizing your net worth, and REITs could certainly be a part of that.

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