Three different types of REITs exist: equity, mortgage, and hybrid. Equity REITs get their income from rents and capital gains from the property they own. Mortgage REITs derive their income pri- marily from the interest income from mortgage loans they enter into. Hybrid REITs are combinations of the equity and mortgage REITs.
There are other ways to invest in real estate, including buying and developing land, purchasing rental properties, limited partnerships, etc. However, I usually advise my clients to invest in REITs, when it is appropriate. I feel that the centralized management and the pass- through of income, which has been as high as 11 percent, outweigh the possible advantages of direct ownership.
It’s important to note that although the income that is distributed by the REIT to its shareholders is taxable to the shareholders, it’s not when the REIT is held in a qualified retirement plan (like an IRA) and reinvested. This is because the interest can flow into a separate account. However, if the qualified plan owner decides to take the interest payments as income, they will be taxed.
WHY BONDS, CASH,AND REITS ARE IMPORTANT
Bonds play an important role in asset allocation because they can provide a level of stability to an investor’s portfolio. No wealthy per- son has become rich, and stayed rich, without some type of bond in his or her portfolio. Bonds, cash investments, and real estate are the cement in a portfolio. They weather the down markets, when all your equity investments are giving you heartache, all the while generating interest income for you, which you can either reinvest, or use cur- rently. For people who are naturally timid about investing, holding REITs, bonds, and cash is essential. However, remember that the price of the bonds and REITs will vary, as do equity investments. The cash positions held by investors will continue to increase, albeit at a slower pace due to the low nature of interest rates for cash securities. Although they tend to look bad when the market is booming and your equity investments keep rising, bonds and REITs provide current income that you may need if you have a large tax bill due to the cap- ital gains and dividends provided by your equity investments. Plus, tax-exempt bonds give you tax-free income now.