Real estate investment trusts (REITs) have become a popular destination for investors seeking big-time dividends. Thanks to how they are structured, REITs pass through the bulk of their cash flows as dividends in exchange for favorable tax advantages at the corporate level. This has them yielding often more than 4%. And as a testament to their popularity, just take a look at the Vanguard REIT ETF (VNQ). Thanks to their hefty yields, the ETF has nearly $35 billion in assets.
But not all REITs are the same.
Most investors and the VNQ focus on REITs that own physical properties – apartment buildings, office parks, and even timberlands. However, there are more than a few ways to get their real estate fix and high dividends, but one way could be downright dangerous in the current environment.
Mortgage REITs 101
The vast bulk of REITs fall into the category of equity REITs. These are firms that own your local shopping mall or apartment complex. Businesses or people rent out space in these properties and the REIT collects a check every month. Easy-peasy and everybody understands them. But the IRS has a very broad definition of what constitutes “real estate.” In that broad definition, not every company qualifies for REIT tax status. (Get a complete understanding of REIT taxes in our Complete Guide to REIT taxes.)