Are REITS Right for Your Portfolio?

If you dream of emulating Donald Trump but don't have millions to invest in real estate, a Real Estate Investment Trust or REIT can provide some of the upside income potential with a much smaller investment.

Simply put, a Real Estate Investment Trust is a way for everyday investors to invest in property and real estate. It can be commercial real-estate, apartments, condominiums, homes and other types of property. REITs specifically invest in properties that produce income and pass on the profit to investors in the form of dividends. In fact, REITs must distribute at least 90% of any profit to qualify for preferential tax treatment.

Investors can buy, sell and trade shares of REITs just as they would a normal stock. However, because a REIT deals with real estate instead of widgets, they differ in how they finance expansion and measure profitability. Normal investor screening criteria like P/E ratios may not apply to a REIT the same as to another equity investment. On the other hand, like a stock, investors in REITS look for trustworthy and competent management and reasonable compensation of those managers.

Real Estate Investment Trusts come in three major forms. The most common and widely purchased are shares of equity REITs, which invest in commercially managed property that produce income. This is generally the type of REIT that is referred to when discussing them as an investment tool.

Less common versions of REITS include mortgage REITs, which make loans to owners of real estate or invest in current outstanding mortgages. According to Investopedia.com, these REITs account for less than 10% of REITs available today. The final version is a hybrid of the equity REIT and the mortgage REIT and also accounts for a small percentage of REITs. These hybrids combine the mortgage investment of one with the property management of the other.

Most REITs contain numerous properties ranging in size, activity and function. Like portfolio diversification, a REIT's diversification may provide some protection from the ups and downs of individual properties such as occupancy rates, defaults on rents, and downturns in industry sectors or local markets. Specialized REITs hold only specific types of property, such as apartments, commercial office space or retail.

Like other investments, REITs carry the risk of loss of investment. Because they can be a complicated investment product, consult your financial professional before investing to better understand whether REITS are right for your portfolio.

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