The Common Sense Investor

There are many investment opportunities that are open to the average investor. But the number of choices also pose a challenge for a person who is not sure how to pick from the many investment offerings available. It is important to understand the critical distinctions between various forms of investment. For that reason, The Common Sense Investor will highlight some of the key distinctive features of various investment vehicles to help you understand how your money is being used.

One type of investment that is often overlooked (at least when they are not in vogue on Wall Street) are REITs or real estate investment trusts.

REITs are trust companies that accumulate money through an initial public offering, which it then use to purchase, develop, manage and sell assets in real estate. The IPO is quite similar to any other security offering and follows the same rules. The difference though is that instead of purchasing a stock in a company, a person buying a REIT unit is in effect also buying a portion of a managed pool of real estate. This pool earns income through renting, leasing and selling of property. The income is then distributed directly to the REIT holder regularly.

Investing in REITs brings with it a number of advantages. First of all, when you buy a REIT you are also purchasing a physical asset that has a long life span and also a long potential for income because of rent and property appreciation. This is a big difference from common stocks where investors are only buying the right to benefit from the profitability of a company through ownership. Buying a REIT means that you are not only placing a stake in the ownership of property by means of the fluctuations in value but also in participating in the income that is generate by the property. This creates a safety net for investors because there is a constant right to the property underlying the trust while also enjoying the income benefits.

Another advantage that can be cited is that a REIT gives the investor the ability to invest in real estate while eliminating or lessening the high demands associated with it (large capital, various labor requirements). Additionally, pooling the funds of the trust also mean that there is a greater amount of diversification that will be made possible as the trust companies are empowered to buy numerous properties while reducing the negative effects of problems that are quite common with a single asset.

Finally, and probably most importantly, REITs are required to distribute almost 90 per cent of their yearly taxable income to the shareholders. This amount is deductible on a corporate level and generally taxed at the personal level. This means that, unlike dividends, only one level of taxation is imposed for the distributions paid to investors. What this translates to is a higher participation in the profitability of management and property within the trust for REIT holders. Less of the profits are taxed and results in a higher dividend yield compared to owning common stocks where the corporation and the board of directors decide if the excess cash is ultimately distributed to the shareholder. The major downfall is that, just as with all dividends, the individual investor is responsible for paying taxes on dividends each year. For this reason, REITs might be better suited in a retirement account where dividends are tax exempt.