Real estate investment trusts (REITs) and stocks provide a way for investors to build long-term wealth. They have some similarities, but knowing their differences helps investors decide which is right for them. Despite their differences, having both REITs and stocks in an investment portfolio can benefit an investor.
REITs are companies that invest in real estate, real estate financial instruments (such as mortgages) or a combination of both. Like other public companies, public REITs must file quarterly and annual financial reports with the Securities and Exchange Commission. Many REITs trade on major exchanges alongside stocks. Unlike other companies, REITs must distribute at least 90 percent of their taxable income to shareholders, and they do not pay corporate income tax on the distributed dividends.
A share of stock represents partial ownership in a company and a claim on all its assets and future earnings. Part of the claim on earnings often is paid out as dividends, or a periodic distribution of earnings. But, unlike REITs, companies aren’t required to pay dividends. Stocks also provide the right to vote on management and other issues.
There are several advantages to investing in REITs. Because of their payout requirements, REITs typically provide a consistent stream of dividends. Investing in REITs also provides diversification through exposure to the real estate asset class, which can benefit an investment portfolio. Because many REITs are publicly traded, they offer diversification with the benefit of liquidity, or the ability to sell quickly, that isn’t typically found in traditional real estate investments.
Stocks have some advantages as well. Because most non-REIT companies have no minimum income distribution requirements, they have more liberty to reinvest their income to grow their business. Stocks also represent ownership in a wide variety of companies and industries, whereas REITs are restricted to real estate. While real estate is prone to cyclical downturns, investors have more flexibility to invest in stocks in growing industries, when other industries are declining.