REITs on a Tear

Relatively speaking, REITs (real estate investment trusts) have been on a roll lately. The FTSE NAREIT Equity REIT Index, for example, was up 1.4% in the first quarter of 2008, while the FTSE NAREIT All REIT Index was down 0.4%. And if those don't sound like great returns, well, consider how the rest of the market did.

The REIT basics
Real estate investment trusts combine the capital of many investors to acquire or finance all kinds of real estate, including offices, hotels, shopping centers, and apartments. A REIT is a little like a real estate-focused mutual fund. Like a fund, its portfolio is professionally managed and diversified, holding many properties. REITs typically trade on major stock exchanges.

But REITs are also unique in many ways. For starters, corporations or trusts that qualify as REITs generally don't pay federal corporate income tax, and they're often exempt from state income tax, too. They're required to invest at least 75% of their assets in real estate, and they must pay out at least 90% of their income as dividends. In good years, REIT dividends can run quite high, sometimes topping 10%. (You can learn more about REITs on our REITs discussion board.)

A real (estate) advantage
In Q1 2008, when the equity REITs rose 1.4% and all REITs dropped 0.4%, the S&P 500 fell 9.4%. The Dow Jones Industrial Average (which contains just 30 companies, by the way) was down 7.6%, and the Nasdaq dropped 14.1%. Being up 1% when an alternative is down 9% marks a 10-percentage-point difference. With a $10,000 investment, that's $1,000 more for you.

True, REITs underperformed the broader market in 2007, though they beat it in several previous years:

Year

All-REIT index

S&P 500

2004

30.4%

10.9%

2005

8.3%

4.9%

2006

34.4%

15.8%

2007

(17.8%)

5.5%

Source: NAREIT.com.

Are REITs for you?
David Swenson, manager of Yale University's multibillion-dollar endowment, whose amazing record includes a 28% gain last year, recommends that typical investors devote 20% of their portfolios to real estate.

If you're interested in adding REITs to your holdings, consider starting your search with those large enough to have made it into the S&P 500. They include Host Hotels & Resorts (NYSE: HST  ) , Boston Properties (NYSE: BXP  ) , Equity Residential (NYSE: EQR  ) , Simon Property Group (NYSE: SPG  ) , and Plum Creek Timber (NYSE: PCL  ) .

If you'd rather not spend the time or energy studying lots of real-estate companies, you might focus instead on real-estate-focused mutual funds, letting smart managers make the buy-or-sell decisions for you. Consider these five- and 10-year compound average annual returns:

Fund

5-year

10-year

CGM Realty (CGMRX)

39.8%

20.1%

ING Van Kampen Real Estate (IVRSX)

21%

12.1%

Alpine International Real Estate (ELGRX)

26.5%

11.2%

Source: Morningstar.com.

A free trial of our Motley Fool Champion Funds newsletter can introduce you to many terrific mutual fund recommendations, including some focused on real estate. (I've found a bunch of winners via the newsletter, myself.) A free trial includes full access to all past issues, so you can read about each recommendation.

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