Ready to Invest in Real Estate?

Real estate seems to be the last refuge for investors.

Individuals see their homes as an investment they can live in, unlike the stock market, where mistakes cost dearly. Others are speculating on condos, putting 10 percent down on units under construction and hoping the market holds up so they can flip their units at a profit when the building is completed.

But those real estate investments are either concentrated or leveraged, adding an element of risk to the stability that real estate is intended to provide in an investment portfolio. For those who want exposure to real estate, plus diversification and an income stream, Real Estate Investment Trusts are the obvious answer.

How REITs Work
A REIT is simply a holding company for real estate properties. Typically, REITs concentrate in one type: apartments, offices, shopping malls, hotels or even storage units. The shares of these publicly traded companies are listed on major exchanges, and dozens of mutual funds invest primarily in the shares of REITS.

More than 180 REITs are publicly traded, with market capitalization topping $150 billion. (Full disclosure: For years I've owned stock in several REITS and mutual funds that buy these shares.)

The attraction for investors is two-fold. First, REITs offer a chance to own a diversified piece of choice properties that could appreciate in value -- especially if inflation returns. And second, these companies are required by law to pay out 90 percent of the rents they collect in the form of dividends to shareholders. Many REITs have dividend yields of 7 percent or more, which is very attractive in today's low-interest-rate environment.

Lately REIT stock prices have weakened as investor concerns about the economy have spread to the companies that rent offices, apartments, shopping malls and hotels. Vacancies mean zero income. If the economy weakens, companies will fail -- and cease paying rent. If workers lose their jobs, they might even be evicted from their apartments.

And without profitable rental income, investors worry that REITs may have to cut those juicy dividends. But REIT defenders say there's a simple way to judge which companies may have shaky dividends. Just look at their income, which in REIT-land is defined as FFO, "funds from operations." Then compare that cash flow to the dividend payout to find out how secure the dividend is.

Many REITs need much lower levels of occupancy than they have today to maintain those dividends. That's because REITs learned their lesson in the late 1980s, when many were forced to cut dividends in order to pay interest on the debt they borrowed to buy the properties in the first place. Today's REITs have far less leverage -- borrowing -- so a decline in rental income does less damage to their cash flow. Still, judging by those relatively high yields, many investors are avoiding REITs in fear of an economic catastrophe. And that creates an opportunity for risk-takers who do some research.

Researching REITs
The National Association of REITs maintains a Web site that makes researching a lot easier. At www.InvestInREITS.com you can get a list of all publicly traded REITs, and a quick link to their Web sites. You can search by category. There's also a listing of mutual funds that specialize in REITs, and you can research REIT funds at www.Morningstar.com.

A word of warning: Whenever you see higher yields, it's inherently true that there must be more risk involved than in an investment with a lower yield, whether stocks or bonds. Ignoring risk is foolhardy, but accepting reasonable risk in a portion of your investments in order diversify and increase the yield can make good sense.

Terry Savage is a registered investment adviser and is on the board of directors of McDonald's Corp. and Pennzoil-Quaker State Co. She is also a national syndicated Chicago Sun-Times personal finance columnist.