What are the pros and cons of REITs?

Buying shares in a real estate investment trust (REIT) has both advantages and disadvantages you'll want to understand before deciding to invest. Some of a REIT's greatest advantages are that it can provide both ongoing dividend income as well as long-term capital gains. The ongoing dividend income can often come from the long-term rental agreements, which can offer a predictable revenue stream that you can access immediately. However, a REIT also has a long-term view as the value of your shares in the REIT can improve as the value of the real estate the REIT holds improves.

Being able to provide both types of income results in various tax advantages and disadvantages. Generally, a REIT can pay out more in annual dividends because it won't have to pay taxes on it as long as the REIT distributes around 90 percent of its annual income. So the good news is that this means the REIT is encouraged to pay out high dividends and has a larger, non-taxable pool of money from which to pay them. The downside is that you will be paying income taxes on the annual dividend as though it were personal income, not a capital gain, once it is distributed.

Some of the value of the REIT can be distributed as a nontaxable return of capital, which means that this portion of the funds isn't taxed as income. However, these long-term capital gains are still taxed, but at the lower capital gains rate.

Another benefit to a REIT is that it can offer some diversification and balancing of your portfolio. Investing in a REIT is a third investing option, in addition to stocks and bonds. A REIT might also be a more stable investment as it's less vulnerable to market fluctuations and inflation. Usually, REIT incomes get adjusted by the cost of living, but they are certainly also vulnerable to fluctuations in the real estate market.