Definition: A REIT, short for Real Estate Investment Trust, is a public company that develops and owns commercial real estate. These are apartment building, office buildings, shopping centers, hotels and warehouses that produce income. Unlike other public companies, REITs must distribute at least 90% of their taxable earnings to shareholders. This saves them the business tax cost, which is paid by the shareholder at the capital gains tax rate.

Buying shares in a REIT is the easiest way for the individual investor to profit from commercial real estate. You can buy and sell shares of REITs just like stocks, bonds or any other type of security. You can see why this is easier and cheaper than trying to buy or sell the actual commercial real estate. 

How REITS Affect the Economy

After the subprime mortgage crisis, thousands of homes went into foreclosure. As home prices plummeted, REITs stepped in to purchase these properties for a song. They had the deep pockets to rent them until a healthy market returned. By 2013, 20% of all homes were bought by investors. Without REITs to take the foreclosed homes off the market, housing prices would have fallen even more than the 30% they did. It still may be difficult for these REITs to sell the individual foreclosed homes, and they may end up holding onto them more than they originally thought.

Pros and Cons of REITs

Since commercial real estate values typically lag those of residential real estate, REIT prices usually don't rise and fall with the stock market.

REITs share this to some extent. In other words, REIT values aren't highly correlated with the rest of the market, making them a good addition to a diversified portfolio. REITs share an advantage with bonds and dividend-producing stocks, in that they provide a steady stream of income. Like all securities, they are easily bought and sold, and are regulated. (Source: "What Is a REIT?" REIT.com)

However, keep in mind that the value of your REIT tracks more than just the underlying real estate. It's also affected by the demand for REITs themselves as an investment. That means they compete with stocks and bonds for investors. Therefore, even if the value of the real estate owned by the REIT rises, the share price could fall in a stock market crash. 

When to Buy and Sell REITs

Commercial real estate trends are usually a lagging indicator. That's because commercial real estate developments are built after residential. Shopping centers, offices and schools are usually built after an area has the homes and shoppers to support it. It can also take several years to construct commercial real estate. During a boom, commercial real estate could be experiencing an asset bubble after residential real estate starts to decline. During a recession, commercial real estate hits its low after residential real estate. Therefore, when investing in REITs, be sure that you are aware of the business cycle and it's impact on commercial real estate.

REITS vs Real Estate ETFs

Real estate exchange-traded funds (ETFs) track the stock prices of REITs. Investors are attracted to ETFs because they have very low fees. However, they are one more step removed from the value of the underlying real estate, and more susceptible to stock market bull and bear markets. (Source: Joanne Cleaver, "The Pros and Cons of Investing in Real Estate ETFs," U.S.News & World ReportI, June 5, 2014)