Some holders of Real Estate Investment Trusts (REITs) and REIT funds believe (and fervently hope) that such performance will continue. Others argue that the glory of REITs may already be gone with the wind. Here are several reasons why REITs deserve a permanent allocation in most portfolios.
Unusually high dividends
REITs typically deliver annual dividend yields significantly higher than even the highest dividend-paying non-REIT stocks, and twice that of the average stock.
So the cash usually keeps flowing regardless of whether a particular REIT’s share price rises or falls, just as long as the REIT is pulling in some money. That’s because REITs, which get special tax status, are required by law to pay out 90 percent of their income as dividends to shareholders. Cool, huh?
Different taxation of dividends
Because REITs are blessed in that they don’t have to pay income taxes, their dividends are usually fully taxable to shareholders as ordinary income. In other words, whatever dividends you get will be taxed at year-end according to your income tax bracket. Few, if any, REIT dividends you receive will qualify for the special 15 or 20 percent dividend tax rate.
Special status among financial pros
The vast majority of wealth advisors — whether they primarily use style investing, sector investing, or astrology charts and tea leaves — recognize REITs as a separate asset class and tend to include it in most people’s portfolios. Is that distinction logical and just?
But one possible reason REITs are seen as a separate asset class may be that the REIT marketers are savvier than the marketers of utility stocks (which, in addition to having low correlation to the broad market, also pay exceptionally high dividends).
Connection to tangible property
Some people argue that REITs are different than other stocks because they represent tangible property. Well, yeah, REITs do represent stores filled with useless junk and condos filled with single people desperately looking for dates, and that makes them different from, say, stock in Microsoft or Procter & Gamble. (Isn’t toothpaste tangible?) But the reality is that REITs are stocks. And to a great degree, they behave like stocks. If REITs are different than other stocks, dividends and lack of market correlation are the likely distinctions — not their tangibility.