For dividend investors, real estate stocks have long been a favorite source of high current yield. But as in most other areas of investing, real estate has its risks.
Before we look at those risks and how to deal with them, let’s define what we’re talking about when we discuss real estate stocks. Most are real estate investment trusts (REITs), which are legal entities created by Congress in 1960 that are intended to foster individual ownership of all types of real estate.
Tax Advantages of Real Estate
In pre-REIT days, individuals found it difficult to participate in real estate. Most large properties were owned by partnerships in order to take advantage of real estate’s tax advantages. These include the ability to deduct the expense of mortgage interest and the ability to depreciate the property over the period allowed by the tax law.
REITs were designed as pass-through entities, meaning that if they pay out at least 90% of their income in the form of dividends, the REIT itself does not have to pay income tax. Of course, the shareowner is taxed on the income received in the form of dividends, but that one-time taxation (similar to the taxation of partnership income but unlike corporate income, which is taxed at the corporate level and then again when distributed to shareholders as dividends) is what makes REITs so popular – and what makes REITs such relatively high-yielding stocks. For more on REIT taxes, check out Dividend.com’s guide.