Profiting From Real Estate - Now It's as Easy as R-E-I-T

IF ''REIT'' came up on a crossword puzzle, many Americans might need more than one clue.

But since the early 1990s, investors have poured billions of dollars into these investments: real estate investment trusts. The market value of their shares has risen 160 percent to more than $100 billion. Assets held by REITs - property, buildings, etc. - are valued at more than $88 billion.

Though the REIT road has its bumps, like any risky investment, shareholders have fared well. Looking at the past five-year period, REITs outperformed a number of benchmarks, including the Standard & Poor's 500 stock index, according to industry officials. The most popular type of REITs, equity REITs, did particularly well (see box). These are diversified holding companies that issue stock shares and buy income-producing property.

Two caveats are in order, experts say. When REITs floundered in past years, such as the early 1970s, massive financial losses resulted for many investors, says Cebra Graves, an analyst with the financial-services firm Morningstar Inc. in Chicago. Second, he says, REITs have accounting methods that, while perfectly acceptable, make it difficult for investors to apply traditional stock-analysis tools (such as the price-earnings ratio).

''The [REIT] industry today is totally different than the industry of the 1960s or 1970s,'' says Mark Decker, president of the National Association of Real Estate Investment Trusts (NAREIT), a Washington-based trade group. Back then, Mr. Decker concedes, REITs were often overleveraged with debt, and some were shoddily managed. Today's REITs are far more shareholder-oriented, he says. Managers are more sophisticated. Leveraging is modest.

Although stressing that he is not a financial analyst, Decker says total return for REITs this year could exceed 15 percent, versus broader stock-market gains of perhaps 10 percent.

REITs have characteristics of both publicly owned companies and mutual funds. They trade as securities on stock exchanges and can be purchased through brokers. Investors can buy into a REIT - and thus, own or finance a part of some real estate properties - for as little as $20 to $50 a share.

Like a mutual fund, REITs are diversified. They offer higher dividend yields than most stocks. ''Investors get a yield kick with REITs,'' says Lisa Sarajian, who follows REITs for Standard & Poor's Corp.

Legislation authorizing REITs was signed into law by President Eisenhower in 1960. REITs were designed to allow small investors to participate in the ownership of commercial real estate and other mortgage-based projects. Thus, REITs are quite distinct from real estate limited partnerships, which are geared to affluent individuals and often have high sales commissions and management fees.

REITs face no double taxation of earnings, unlike stocks, with taxes on both corporate earnings and shareholder dividends. Under federal law, earnings for REITs are not subject to the corporate income tax. Most states also decline to tax REIT earnings. By law, at least 95 percent of earnings must be passed to investors.

Of 215 publicly traded REITs, 141 are listed on the New York Stock Exchange, 54 on the American Stock Exchange, and 20 on the Nasdaq market.

Three main types exist:

1. Equity REITs make up 87 percent of all REITs; they own real estate assets. Revenue streams come largely from rent payments.

2. Mortgage REITs account for 6 percent of the REIT universe; they lend money to real estate owners or invest in mortgage instruments. Revenue comes largely from interest paid on mortgages.

3. Hybrid REITs combine equity and mortgage instruments and make up 7 percent of REITs.

To acquire a list of publicly traded REITs, send a stamped, self-addressed envelope to NAREIT, 1129 Twentieth Street NW, Suite 305, Washington DC, 20036-3482. The group can also be reached at 1-800-3-NAREIT.

Another way of buying REITs - and perhaps the easiest path for individual investors - is to buy into real estate mutual funds. Fund managers buy shares of diverse types of REITs.

For the 12-month period ending in February, the best-performing real estate fund tracked by Morningstar was Evergreen US Real Estate Equity Fund. It has three classes of shares; one class posted a 33.7 percent return, Mr. Graves says. Another top fund was CGM Realty Fund, which returned 29 percent. Both are considered somewhat bold in terms of risk taking. A more conservative fund is the Templeton Real Estate Securities Fund, with an 11.79 percent return. Other well-regarded funds include the Fidelity Real Estate Investment Fund and the Cohen & Steers Realty Shares.

While real estate mutual funds do well, they still typically trail stock-market averages, Graves says.

Still, he says, buying into real estate mutual funds can make sense. ''The funds, because they are in real estate, do not move in tandem with the overall stock and bond markets. Thus, they provide genuine diversification.''