With the real estate market in the tank, many investors are thinking twice about real estate investment trusts, or REITs. And that suits Jim Johnson just fine.

“If no one else wants them, great, I’m here to buy them,” says Johnson, a certified financial planner at Lighthouse Financial Planning in Folsom. “People make money when everyone else is scared to death. Everyone is wondering, ‘Is this year or last year the bottom?’ I don’t know, but you can buy real estate a darn sight cheaper than three or four years ago and that’s a good thing.”

A REIT is a tax designation for a corporate entity investing in real estate. The purpose of the designation is to lower or eliminate corporate tax, and in return REITs are required to distribute 90 percent of their taxable income to investors.

REITs can be privately or publicly held and may be listed on the public stock exchanges. Investors buy REITs as they would regular stocks, paying attention to the dividend yield, or the percentage of the share price paid out as dividends.

Once the bastion of retired investors, the sector is now an increasingly common avenue for diversifying portfolios across the board. While most REITs buy and manage shopping malls and apartment buildings, health care facilities, senior living complexes and public storage units are REIT growth sectors, along with hotels and data centers.

REITs have taken some blows from the economy. One recent REIT index showed drops of 19 percent since July, compared to 16 percent for Standard & Poor’s 500-stock index.

But with mortgage rates at historic lows and housing prices in the cellar, investors looking for real estate income can still find deals in shares of professionally managed property portfolios. Many advisors are seeing opportunity in today’s low interest rates, along with strong demand and tight supply.

Tim Bonang, vice president of investor relations for REIT Research and Management in Newton, Mass., says REIT tax laws were created in the 1960s so individual investors could own real estate as an asset without having to own an office building.

“REITs have the advantage of a real estate investment, with the liquidity of a publicly traded company,” Bonang says. “Investors can buy and sell shares without having to sell the whole building. Over time, especially since the early 1990s, REITs have become more of a core holding for many types of investors.”

Bonang says there are about 130 publicly traded REITs nationally, and many diversified investors typically sink 5 percent to 15 percent of portfolios in REITs. REITs are often viewed the same as financial stocks, he says, and the funds are not just for retirees anymore.

“Because they have to pay out 90 percent of the taxable income to investors, they are a mainstay of retirees, or anyone on a fixed income,” Bonang says. “It’s now for anyone looking for a steady dividend.”

REITs are a way for investors to dabble in the real estate market without having to expose themselves to some of the risks associated with the downturn in stocks.

Lori Ackerman, a financial adviser at Parkshore Wealth Management in Roseville, says commercial REITs have been a strong component of portfolios for several years, with offices and retail sectors standing out and public storage units growing as a category.

“When investing, we want to make sure if one sector goes down, others don’t necessarily go down,” Ackerman says. “REITs are not highly correlated to the stock market, so that provides us diversity.”

She says REITs operate much like a mutual fund, and like any asset can fluctuate in value, “but it’s a little different because 90 percent of the income must be distributed to investors.”

Her firm maintains about 10 percent of its portfolio in REITs.

“It provides a level of diversification that we would be lacking if we were investing in just stocks and bonds,” she says.

When choosing a REIT fund, Ackerman advises looking for one with a low expense ratio, the percentage charged for money management.

“With any investing, and certainly with REITs, you want to be careful with expense ratios,” she says. “It’s one of the most important things to watch out for when investing in mutual funds. The average person sees that number and thinks it’s just a number, but it’s a sneaky thing. It’s never explicitly charged to the investor, and they aren’t always made aware of it but it comes out of the fund.”

Harold Anderson, president of Parkshore Wealth Management, says the biggest advantage to publicly traded REITs is liquidity.

“A publicly traded REIT is on the stock market and very liquid,” he says. “The liquidity is within a day or two, depending on when you buy. Everything we do has one-day liquidity. Having liquidity when you need it is important in this environment.”

Anderson recommends investors double-check liquidity on privately traded REITs, watch the equity ratio and be mindful of the management of the property.

“You have to look at the nature of the offering,” he says. “Look at the liquidity and be aware, or you could lose money really fast if the mortgage defaults.”

According to Anderson, some of the best-performing REIT sectors currently are mini-storage units, office buildings, fast-food restaurants and assisted-living facilities. He says the basic REIT structure is a pass-through entity with the end user paying the tax on the income.

“Basically, an investment company goes out and finds investors who put up a pool of money,” Anderson says. “The company will buy pieces of property according to their goals, and the company holds and manages the properties. It’s different than a partnership because losses don’t pass through to an investor, but the income passes through.”

“When investing, we want to make sure if one sector goes down, others don’t necessarily go down. REITs are not highly correlated to the stock market, so that provides us diversity.”

— Lori Ackerman, financial adviser, Parkshore Wealth Management

Anderson says many different REITs serve varying purposes for investors. While some can be tax-free, others allow losses to offset future distributions of income, while others are used for income.

“Many pay more income than a bond,” he says. “But there’s more risk. If the mortgage goes bad, you can lose a lot of money fast. I’ve seen a lot of people in search of income, so they buy into a REIT that pays an 8 percent return, only to have it go under. Then there’s no return.”

Johnson keeps about 5 percent of his clients’ portfolios in REITs, depending on the individual investor’s goals. He invests through mutual fund managers.

“As an allocation of assets, I always include real estate, and then I may increase or decrease the amount in portfolios,” Johnson says. “But I’m always investing in real estate. It has certain advantages and can bring a level of stability to a portfolio. And they have a pretty nice yield in today’s world, getting 3 or 4 percent.”

He advises not to be too concerned about tax relief; instead, look at returns when choosing a REIT.

“The tax advantages are insignificant,” Johnson says. “Don’t let the tail wag the dog. Go on quality of investment. Taxes are just a little extra spice, not the reason to invest in REITs.”

Because of the recent souring of the residential real estate market, it’s understandable that investors may be nervous to test out REITs. But Bonang reminds consumers there are two separate sectors of the market.

“During the recent recession, there’s been some confusion between the housing market and commercial real estate,” he says. “There may be some situations where some REITs had to go to capital markets to raise equity to clean up balance sheets, but there’s been very few where commercial property valuation has dropped below the mortgage.”

Anderson agrees public perception of overall real estate markets has given REITs a black eye. He notes
REITs outperformed the stock market in the past couple years, partially because investors sold off REITs during the real estate slump. Now, prices on REITs have spiked during the recent real estate crisis.

“Demand for assisted living is on the upswing, and that’s not affected by people losing their houses. Just because it’s labeled real estate, doesn’t mean it’s doing poorly, because there are sectors doing quite well,” Anderson says.

Simon Property Group Inc., the largest publicly traded REIT, owns many shopping centers, including the Folsom Outlets. The second-largest is Public Storage, which also has a presence in the Sacramento area. Anderson says mini-storage units are hot because of the stalled economy and development of smaller residential lots.

“New residential construction has more small lots with smaller garages,” he says. “We see people with a lot of junk, and they need to rent a storage unit. Also, with people in motion, including short sales, scale-downs and foreclosures, they’re putting their things in storage until they figure out where they’re going to land.”

While the value-to-equity ratio on REITs has been pulled down with the rest of the markets in the past couple months, Bonang says leverage on REITs is running at about 60 percent, still giving investors “quite a good cushion.”

Health care REITs, including the subset of senior living facilities, are growing to be the third-largest group by market capitalization behind malls and apartments, Bonang says.

“The stock prices are holding up well as baby boomers are approaching the older time of their lives or their parents are,” he says. “We’re seeing a flight to a safe sector. Health care REITs are benefiting from an aging population, with baby boomers and 85-plus seniors moving toward retirement and senior living communities. It’s a space that’s holding up well.”

Bonang says health care has been fragmented in the past, with the top 25 operators of senior community unit counts in the U.S. making up less than 10 percent of the total units. The fragmentation creates an opportunity for REITs.

“There’s been a lot of mom-and-pop enterprises, lots of operators and owners and some religious organizations that own senior communities,” he says. “That’s good for REITs because they have access to capital through equity or debt offerings. They have a bit of an advantage to look at acquisitions and put together one or many in a portfolio. They can take the rollup in the industry, and they’re in the best position to invest in the health care segment.”

The largest health care REITs have aging-in-place complexes, which include phased-in living options, from senior apartments to skilled nursing facilities, Bonang says.

He says dividend yields on health care REITs range from 4.7 percent to 7.2 percent.

“Those are pretty healthy returns compared to CDs or savings accounts,” Bonang says. Health care REITs also would benefit from a lack of development and a drop in the number of senior units built in the past two years.

Medical offices are another growing subset of health care REITs, again the result of aging demographics and seniors making more visits to doctors’ offices.

“REITs that own property on the campus of hospitals or adjacent to hospitals are doing well,” Bonang says. “Doctors don’t sign long-term leases, but they do renew often and tend to stay in the same place.”

Biotechnology spinoffs will see growth as a health care subset, Bonang predicts. Meanwhile, the average yield on shopping center REITs is about 5.7 percent. And with the ailing housing market, REITs investing in apartments are posting sturdy returns as more young people decide to rent and homeowners move into rentals as a result of foreclosure or financial downsizing. The current average yield for apartment or multi-family residences is 4 percent.

“REITs are not a panacea, but they are a good balance,” Anderson says. “Would I buy it 100 percent? No way. Would I use it as a piece of my overall strategy? Yes, it’s a great piece to have.”