Real estate investment trusts are holding companies that own real estate on behalf of their investors, much like mutual funds. When you buy stock in a REIT, you buy a small chunk of its investment real estate portfolio and you also buy the rights to the cash flows that come from the real estate. While REIT yields vary based on the particular REIT and its holdings, one common thread is that REITs are legally required to pay dividends. If you don't need the money to live off of, you may choose to reinvest those dividends.
REIT Dividend Reinvestment Plan
Some REITs now offer their own dividend reinvestment plans, often called DRIPs. When you participate in a DRIP, the REIT uses the money that it would pay you in dividends to buy more shares of itself for you. The benefit of using a DRIP is that your money gets quickly reinvested and that you don't have to pay commissions on the transaction. The drawback is that every quarter you buy more shares, and you have to keep those share purchase prices straight.
Reinvesting REIT Dividends
If you choose to have your REIT dividends paid into your brokerage account, you can reinvest them as you see fit when you choose. One option is to wait until the end of the year to reinvest them in a lump sum for easier bookkeeping, even if you miss out on some return. Another option is to reinvest them in a different REIT or in a different investment altogether. This can increase your diversification over time rather than putting the money back into the same REIT and concentrating your holdings.
Dividends in Taxable Accounts
If you hold your REIT shares in a taxable account, you will have to pay taxes on your dividends whether or not you reinvest them. Since REITs do not pay taxes on their profits, their dividends are taxed as regular income. This is one reason that you might want to pull some of your dividends out to pay your taxes and then reinvest the rest.
Dividends in Non-Taxable Accounts
When you hold REIT shares in non-taxable accounts, you do not have to pay taxes on the dividends when they get paid out. You also should not have to track the purchase price of shares that you buy, since you'll either pay tax on everything that comes out of an individual retirement account or 401(k), or pay no tax on anything that comes out of a Roth IRA, assuming that you only take allowed distributions. With this in mind, you can continually roll your REIT dividends back into the REIT or into other investments if you prefer.
When you own shares in a private REIT, your dividend payments and your ability to reinvest them will be determined by that REIT's rules. If you are invested in a private closed-end REIT, you probably will not be able to reinvest in it, since closed-end funds will not take additional investment once they are fully funded. You still can use your dividends to buy other REITs or investments, if you wish.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.