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REITs can boost yield returns, but buy cautiously

If you're looking to increase your portfolio's income, real estate investment trusts, known as REITs, might be an option worth exploring.

Research has demonstrated that REITs can add return while reducing risks, even for fixed-income portfolios, since the correlation between equity REIT returns and other stocks and bonds is relatively low. REIT yields are noticeably better than those of stocks, although down considerably from a few years ago.

But do your homework. While some experts say REITs still seem capable of generating decent returns for another couple of years, others say the sector is showing signs of slowing, and it may be a little late in the cycle.

REITs, according to the National Association for Real Estate Investment Trusts, or NAREIT, are companies that own and most often actively manage income-generating real estate -- usually commercial. For this article we'll be looking at REITs that you can buy as individual stocks or in mutual funds.

NAREIT says REITs are up 22.5 percent from January 2006 through September 2006. In addition, their returns over the last 10 years are impressive. The total return consists of the stock price appreciation and the dividend yield.

Equity REIT index
Compound annual total returns

Source: NAREIT

The equity REIT index has an average dividend yield of 3.86 percent. The yield has dropped steadily from 7.52 percent in 2000. Nevertheless, the current yield remains significantly higher than the average yield of the S&P 500, which was 1.85 percent at the end of September, according to Standard & Poor's.

And when bond interest rates were declining several years ago, REIT yields surpassed them by several percentage points. Advocates say that's the whole idea; that the diversification smoothes out income over the long term.

REITs generally have high yields because they must distribute at least 90 percent of their taxable income to shareholders each year to qualify for tax breaks. In the following chart, components/price is the percentage change in the overall average price per share in the index when compared to the previous year.

Equity REIT index
Year Total return (%) Components/price (%) Dividend yield (%)
*As of 10/4/2006
 

Source: NAREIT

"The strong performance is a good story, and we encourage investors to look at it," says Abby McCarthy, senior director of industry information and statistics for NAREIT.

Ibbotson Associates, the asset allocation company, looked at 30 years of data and found that by adding real estate to a well-diversified investment portfolio, return is increased and risk is decreased. Even a portfolio consisting entirely of bonds and Treasury bills showed higher returns and lower risks over the long run when REITs were added.

The real estate trusts have consistently outperformed the S&P 500, the Dow Jones, the Russell 2000 and the Nasdaq averages for five, 10, 15 and 20 years.

You can buy REITS as individual stocks or mutual funds. Most real estate mutual funds own the same REITs you can buy individually, but you'll get professional management plus an inexpensive way to diversify property types and geographic locations.

Mark Carruthers, a Certified Financial Planner in Garnerville, N.Y., describes REITs as a good investment.

"Pure and simple, it diversifies a portfolio," he says. "There's a misconception when people talk about REITs; they think of real estate in general. REITs are publicly traded companies that deal primarily with commercial properties.

 
 
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