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Best Bets: Revisiting REITs

If you’re unprepared to produce a 20 percent down payment, or the notion of becoming a landlord is unappealing, one of the easiest ways to purchase income-producing properties is through Real Estate Investment Trusts (REITs).

REITs are companies that own and usually operate residential and commercial real estate businesses, such as apartments, shopping centers, offices and hotels.

Their shares are freely traded on the major stock exchanges, allowing small investors to purchase a stake in professionally managed real estate within a diversified portfolio.

REITs are required to distribute at least 90 percent of their taxable income each year to shareholders, making them attractive investments to those who desire both a liquid asset and a large annual dividend.

“In general, this is a good time to start buying REITs,” said Morningstar analyst Heather Smith, adding those that invest in health care properties, including hospitals and assisted living facilities, are particularly undervalued. “A lot are trading below their net asset values so it’s not a bad time for bargain hunters to get in."

The other advantage to owning REITs, said Wyss, is their low correlation with stocks and housing prices – meaning REITs often zig when the rest of the market zags.

“From a diversification standpoint, I like REITs in a portfolio because they give you some protection when the stock market goes south,” said Wyss, adding office, retail warehouse and hotel REITs have a lower correlation with housing than those that invest in apartments.

The National Association of Real Estate Investment Trusts (NAREIT) reports the FTSE NAREIT All REIT Index, comprised of all publicly traded US REITs, returned roughly 158 percent between December 2001 and September 2007 – the most recent month for which data are available.

As of Aug. 31, the index had returned less than 1 percent in the past year, 14 percent over the past three years, 18 percent over the past five years and 11 percent over the past decade.

By comparison, the S&P 500 returned 15 percent during the last year and 12 percent over the last three- and five-year periods. Its 10-year return is less than 7 percent.

For investors looming for an extra edge, Smith of Morningstar says look for REITs that own assets on the more stable east and west coasts “simply because the fundamentals have hung in there.”

“In general, the pull back you’ve seen [in REITs this year] hasn’t been driven by any real weakening in the fundamentals, but the fact that demand has really dried up for commercial mortgage-backed securities and the fact that, in the last couple of years, there’s been a premium built into [REIT] stock prices,” said Smith. “Now that that premium is gone, we see upside potential for retail REITs and hotel REITs as well.”

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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