REIT vs. REIT ETF

A real estate investment trust is a company involved in the ownership or financing of real estate. REITs work under special tax rules that allow them to not pay income taxes if at least 90 percent of net income is passed through to investors as dividends.

This pass-through requirement means that REITs often are viewed as income investments and judged by dividend yields. A REIT's share price can increase because of rising real estate values or the ability of a company to increase the dividends paid to investors.

As of early 2013 there were about 160 REIT stocks. REITs usually specialize in one sector of the real estate market, and the different stocks often are divided into subsectors.

Property type sectors include office buildings, industrial/commercial buildings, shopping centers, apartment complexes, health care facilities and hotels. Some specialty REITs own properties such as data centers, self-storage units and timberland. Financial REITs provide financing for commercial or residential properties or own mortgages on them.

There is a pretty sharp divide between the financial REITs and the property-owning companies. Property owners can increase rents, build new buildings or buy more property to boost the business. Dividend yields will be lower, but investors can get both dividends and value growth.

Financial REITs function more like banks in the real estate world, dependent on interest rates and the amount of buying and selling in different real estate markets. Financial REITs often sport some of the highest dividend yields in the stock market, but their share values are more tied to economic factors. About 25 REITs work the financial side of the fence.

A REIT ETF will own shares of the different real estate stocks to match a specific REIT index. Most ETFs in the sector own property-type REITs and don't own shares of financial REITs. A couple of ETFs cover the financial side and do not own any property-owning companies. The holdings of an ETF are not actively managed.

In most cases, the index that an ETF tracks will give the most weight to the biggest companies. You will find that REIT ETFs are top-heavy, with smaller REITs making up very small portions of total ETF value. The top 10 REITs make up about half of the sector's market value.

The top-heavy weighting of REIT ETFs is not really a negative factor. The biggest REIT companies got that way mostly by doing a better job than the competition. A REIT ETF will provide a stable, dividend-paying addition to your portfolio.

However, there are still nuggets to be found among the smaller REIT companies. The commercial real estate world has its own way of making money. If you like to research stocks, digging into individual REITs will teach you a lot about the commercial real estate markets.