Real Estate Investment Trusts (REITs)

When the stock market goes down, a diversified portfolio can help ride out the storm. Real estate is an investment that can help buffer the market's mood swings.

Portfolio diversification can help ensure stable financial returns, even in uncertain times. You may already have a healthy combination of stocks, bonds, and mutual funds. But have you considered adding a dash of real estate to the mix?

Understanding REITs

If you're concerned that you don't have the wherewithal to be a landowner, don't worry. You can add real estate to your portfolio without actually owning any land or buildings. A real estate investment trust (REIT) gives you a much less capital-intensive way to ride the ups and downs of the real estate market. And it's just as easy as buying stock.

REITs are corporations with a special, beneficial tax status. In return for that advantage, the REIT must meet certain requirements. First, it must make its money from real estate operations. Second, a percentage of the profits are required to be paid to shareholders in the form of dividends. Not only can REITs help diversify your portfolio, they can be great vehicles to generate income.

There are a few different types of REITs. Some buy, sell, or rent residential properties. Others own land zoned for business use, generating income from office leases or through operating shopping malls. Still others are essentially mortgage lenders.

If you'd rather not pick and choose between these specialized varieties, there are mutual funds and Exchange Traded Funds (ETFs) that consist of nothing but REITs. Once you decide how specific you want to get, it's easy to find a REIT that's right for you.

Are REITs a stock?

REITs are really a specialized form of stock or mutual fund. However, there's one huge difference: Since they're specifically tied to real estate, they don't tend to move with the stock market's swings. There's virtually no historical statistical correlation between REIT performance and the S&P 500's performance. That's why a sensible mix of the two makes a great diversification technique.

When the housing market is doing well, REIT shares gain value. They also make greater profits and pay most of that to you, the shareholder. If you reinvest those juicy dividends, you have a cash machine in your portfolio.

This doesn't mean that you should go all in with REITs. The tendency to zig, whether or not the stock market zags, doesn't matter if that's the only investment you have. The stabilizing effect only works if you have a combination of different kinds of equities. A real estate crash could hurt an all-REIT portfolio in much the same way that another Black Friday could devastate an all-stock portfolio.

REITs can be a powerful instrument in your money management tool belt. If you're saving and investing for retirement, a REIT can right a portfolio imbalance and offer you peace of mind in turbulent stock market times.