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Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

What is a REIT?

REIT is an acronym for real estate investment trust. It's an organization that pools investors' money to invest in commercial real estate.

Most REITs invest in the equity in real property, some in mortgages and some in both. Equities have a better performance history and are the Diva's REIT of choice.

Shares in a real estate investment trust are called units.

The REIT's claim to fame is that it pays no income tax on its earnings. Instead, it has to distribute 95 percent of its net income, and the distributions are taxed to the unit holders as dividends.

When a company such as Coca Cola, Philip Morris or The Home Depot pays dividends, the dividends are taxed twice. First, the corporation pays income tax on its earnings. Then, when it distributes after-tax dollars as dividends, these dollars are taxed again to the shareholders. That's two times -- one time too many for the Diva.

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REIT -- what's the upside?

  • You can invest in commercial real estate even if you can't afford to buy the whole apartment building or strip mall.

  • Risk can be spread over many real estate investments in many geographical areas.

  • Units are bought and sold like stocks -- on the New York Stock Exchange and the other major exchanges. You can also buy them in mutual funds and variable annuities.

  • The investment provides an income stream. The income is taxable, so you might want to consider it for your individual retirement account.

  • Real estate can serve as an inflation hedge.

REIT -- what's the downside?

  • Real estate is cyclical -- unlike Coke and cereal, which sell in good times and bad. Real estate investments can tank if the economy takes a dive. Be prepared for a roller coaster ride.

  • They're trickier to analyze than stocks. REIT earnings are not always reported the same way, so traditional analysis, such as the P/E ratio -- where price is divided by earnings -- can be meaningless. FFO, or funds from operations, is a more meaningful number than earnings for REITs, and the price divided by the funds from operations, or P/FFO, is a better valuation ratio than P/E.

For more information on REITs, visit the Web site of the National Association of Real Estate Investment Trusts.

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