REITs have been in the news quite a bit recently. It's no wonder - REITs outperformed the major US stock indices last year, with the NAREIT All-REIT Index increasing 27.45% for all of 2009; versus the Dow Industrials at 18.82% and the S&P 500 at 26.46%. e most staggering performance was from the All-REIT index low of the year on March 6, up 113% by year-end. For the decade, REIT indices outperformed the S&P 500 by a factor of ten.

REIT is an acronym for "Real Estate Investment Trust". Generally speaking, a REIT is company that owns and operates income-producing real estate or mortgages. Equity REITs own properties, Mortgage REITs own mortgages or mortgage backed securities, and Hybrid REITS own both properties and mortgages. REITs enjoy a special tax passthrough status with the IRS if they pay out at least 90% of their income in dividends, among other requirements.

REITs offer investors the opportunity to invest in Real Estate without having to find and select properties, purchase them and manage them. Moreover, REITs offer risk reduction through diversification for small investors. Individual investors can invest relatively small amounts of money in professionally managed income producing properties through REITs. Individuals who are occupied with professions or non-real estate related businesses can participate in real estate investments without having to spend the time and resources required to adequately investigate and negotiate purchases and perform ongoing asset management and property management functions.

Unlike many forms of real estate investment, REITs are accessible to individual retirement accounts and small pension funds without adverse tax consequences. An accredited investor could allocate funds from his or her self-directed IRA into private or public REITs. Retirement fund custodians such as E*Trade and Wells Fargo allow individuals to direct their investments into REITs. Even 401K plans can be structured to allow for diversification into real estate by allowing REIT investment.

Diversification is an important tool for minimizing overall investment portfolio risk. Advisors counsel investors to allocate their funds among assets that behave differently in various market conditions. In order to achieve this, one must find assets with low correlation - a measure of how much returns from different assets move in synch with each other over time. According to the National Association of Real Estate Investment Trusts (NAREIT), REITs have a very moderate correlation to other stocks and bonds over time and therefore provide a potent diversification tool.

REITs can be publicly traded on a stock exchange. According to NAREIT, there are 135 REITs listed on US stock exchanges. REITs can also be registered with the Securities & Exchange Commission, but not traded on an exchange. These public/non-traded REITs can be advertised and sold publicly without any exemptions from registration from the SEC. The share price of non-traded REITs is set by the REIT's Board of Directors and usually reflects the underlying value of the REIT's assets. REITs that trade on an exchange are subject to share price volatility that reflects market sentiment rather than intrinsic value.

Private REITs, like public non-traded REITs, are not traded on an exchange and set their share price based on the value of the underlying assets. Like their non-traded public counterparts, they are not subject to the volatility and vagaries of the public market. However, private REITs may not be advertised or sold through a "public" offering. Instead, they are sold by private placement; usually to accredited individual investors or institutional investors. By selling shares privately to only accredited investors, the REIT can utilize an exemption from registration under the Securities Act of 1933 and save their shareholders from the costly quarterly filings with the SEC. Legal and accounting fees for small public companies that report quarterly to the SEC often run upwards of one million dollars per year. While private REITs incur legal and accounting fees to report to their investors, they can do so for a fraction of the cost that public companies pay.

Public non-traded REITs and private REITs may decide to list with an exchange at some point in order to achieve liquidity for their investors. Alternatively, a private or non-traded REIT may merge with a public company and give their shareholders tradable shares in exchange for their original non-traded shares. Either scenario enables the REIT to offer liquidity to investors without actually liquidating its real estate or mortgage portfolio.

For a real estate company to qualify as a REIT, the IRS has set out extensive rules for compliance. In general, a REIT must have a minimum of one hundred shareholders, it must pay out a minimum of 90% of its taxable income through dividends each year, and its assets must be qualifying real estate investments. With the requirement of having 100 shareholders, it is important that the REIT address the SEC laws for mutual funds under the Investment Company Act of 1940. If the REIT does not qualify for exemption, it would have to go through the costly daily, quarterly and annual reporting of a mutual fund. With all of the complicated compliance requirements that are placed on a REIT, it is important that management, in cooperation with their legal and accounting firms, perform quarterly testing of assets and income, as well as periodic testing of ownership, to make sure that they continue to qualify as a REIT under the IRS rules.

REITs pass through their taxable income to investors without paying tax on regular rental income. Capital gains may also be passed through to shareholders, or they may remain in the REIT and be taxed at the REITs rate. REITs can be structured to avoid Unrelated Debt Financed Income tax in individual retirement accounts.

REITs assist investors in achieving portfolio diversification, tax benefits, liquidity, professional management on the asset and property level, as well as the protection of the securities laws. According to NAREIT, investors have historically looked to REITs for reliable and significant dividends. REITs' qualities of diversification and reliable dividends, when taken together with their historical superior capital gains performance makes them a powerful investment that should be considered for inclusion in any long term investment strategy.