2004-12-16 / Business & Finance

REIT’s Another Investment Option

In the first six months of 2003 the Dow Jones Industrial Average (an in-dex of 30 mega large stocks) went up by 12%, the Standard and Poor’s 500 (a measure of the 500 largest stocks) was up 15% and the NASDAQ (a computerized hodgepodge of mostly small stocks) went up a whopping 25%!

But many investors didn’t notice or didn’t care because the market was not yet back where it was 31/2 years earlier. So naturally, people think of alternatives to the stock market.

Real estate is natural. In many cases, folks watched the value of their dwellings increase more than their stocks decreased’ so they figure, “Real estate is great.” This may be true; how-ever, investing in real estate can be a minefield. Here is a five question quiz that will help you determine whether or not you are a potential real estate investor.

Question one—Can you tie up the necessary capital for a minimum of several years? Despite what the in-fomercials on late-night television suggest, i.e., you can buy property with “no money down,” real estate typically requires a fairly large capital in-vestment.

In addition to a down payment, you may need funds for repairs and maintenance, taxes, and other expenses. All of which makes it difficult for the ave-rage investor to build a properly diver-sified real estate portfolio.

Question two—Are you likely to remain in the same geographic area for the foreseeable future? Real estate investments generally require a lot more personal attention than do stocks, bonds or mutual funds. And, don’t think you can just drive by once in a while to see how things are going.

Unless you can afford professional management of the property (which will increase your cost and decrease your profit), you’d better count on a significant commitment of your time to managing even a single piece of real estate investment property.

Question three—Do you have the time, talent and temperament to manage property effectively? Real estate is much more of a “hands on” investment than are stocks, bonds, or mutual funds. You’ve generally got to make a commitment of time to find tenants, make repairs, keep records, and otherwise manage the property.

Question four—Can you assume the substantial risk inherent in real estate investing? After the stock market’s performance over the past few years, you may be thinking that nothing could be riskier. However, real estate has some unique risk characteristics that you should recognize. For one, there’s generally a lot of borrowed money involved, which means you’re using a lot of financial leverage, which in turn carries a risk. Additionally, selling a piece of property isn’t quite as easy as calling your broker and saying, “sell.”

Question five—How’s your credit? Do you have the credit standing necessary to borrow on the most attractive terms? Investing in real estate is one thing, doing it profitably can be another. Financing is a key part of these investments and having access to low-cost capital is critical. Even if the property is used to secure a mortgage, the borrowing rate, points paid, insurance fees, and other costs will have a big impact on the overall rate of return.

If you answered “yes” to all of these questions, then perhaps real estate may be a worthwhile consideration for you. However, if you truthfully answered “no” to even one of them, you ought to think long and hard before making any commitment to owning rental property.

This doesn’t mean, however, that you can’t invest in real estate. There are a number of “indirect” ways to do so that are also attractive. A Real Estate Investment Trust (REIT pronounced reet) is a security that sells like a stock on the major exchanges and invests directly into real estate, either ,through properties or mortgages. REITs receive special tax considerations, and typically offer investors high yields as well as a highly liquid method of investing in real estate.

REITs come in three flavors: Equity, Mortgage and Hybrid.

Equity REITS invest in and own properties (and are thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties’ rents.

Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money to real estate owners for mortgages or invest in (purchase) existing mortgages or mort-gage backed securities. Their reven-ues are generated primarily by the in-terest that they earn on the mortgage loans.

Hybrid REITs combine the investment strategies of Equity REITs and Mortgage REITs by investing in both properties and mortgages.

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