Pros and Cons of Real Estate Investment TrustsUnderstand the pros and cons of real estate investment trusts before jumping in. Real estate investment trusts have both advantages and disadvantages.

Q: We are retired and our investment advisor suggested that we invest in REITS. Would this be a good idea? We have about $270,000 in assets and he wants us to invest about $30,000. We own our home without a mortgage.

A: Let’s start with the fact that we aren’t investment advisors and you’ve hired one to help you. But it’s also clear that you don’t fully trust your investment advisor (or you wouldn’t be writing to us) and that you don’t understand the investments he has recommended.

That’s not a good situation to be in, particularly when you’re retired and are looking to preserve capital.

You need to talk to your investment advisor to get a better understanding of the pros and cons of owning a real estate investment trust (REIT). We know you don’t want to appear uninformed, so perhaps we can shed some light on what a REIT is and why your investment advisor might be suggesting you invest in them.

REITs are a way to own real estate without actually tying your money down in a specific property. You could easily imagine a REIT being a mutual fund made up of buildings, bridges, hospitals or mortgages. When you own a REIT, you own an interest in the portfolio of many real estate products that the REIT owns.

According to the National Association of Real Estate Investment Trusts (NAREIT), which publishes REIT.com, to qualify as a REIT a company must “distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.” Shareholders pay tax on dividends received and any capital gains earned.

There are two ways to make money with a REIT: You may receive dividends or capital gains payouts annually, which are taxed in different ways (the REIT keeps track and provides paperwork for you every year), and the share price might go up in value.

One of the best things about a REIT is its liquidity. If you own an investment property, you have a relatively illiquid investment in real estate. As we’ve seen over the past few years, it’s often hard to sell a house when you want, as the value rises and falls because of external forces beyond our control. But REITs trade on the stock market and are regulated by the Securities and Exchange Commission (SEC). If you needed to sell your shares instantly, there will likely be a buyer for them. You can cash out on a whim.

How a REIT would work in your portfolio is hard to say. You are retired and are looking for a certain stream of income during your retirement. In years past, retirees might have put their money in utility stocks that generally paid a certain dividend or in government bonds or bank certificates of deposit that paid a fixed sum over the life of the investment. A REIT would generate cash from the rents that are collected from commercial property it owns or from the monthly payments on the mortgages it holds.

With interest rates at record lows, people are looking for other places to put their money. Some might put that money in stocks – perhaps even stocks that have a high dividend yield – or other investments that traditionally might not be good investment choices for retired people. When you invest in stocks, you risk that a particular stock might go way down in value. If you invest in an index fund, you risk that the stock market as a whole might go down. In either of these cases, your risk is that you might lose money.

The same might be true with a REIT. While we seem to be at the end of the great recession and real estate values have stabilized in many areas and are increasing in others, the question for you to decide is what kind of a risk do you want to take with your money.

Your investment advisor seems to recommend less than 10 percent of your money in a REIT, which is a cautious amount. If we had to guess, we’d say he is trying to augment your annual income for retirement, but not lose out on all of the opportunity for share price increases.

If he is recommending a well-run REIT, with smart managers who have helped build it over a substantial period of time, then it might be a great investment for you. If his company is trying to push oblivious investors into a REIT that’s untested or has a poor track record compared to others in the same category, then that’s not so good. You will need to do your own investigation. Morningstar.com might be a good resource, as is REIT.com for more background information on this type of investment.

REITs have done very well as an investment category over the past few years, but there are those who believe that future earnings will be more tempered. There is also the problem that it’s difficult to understand what the true costs of the REIT are and how those costs are distributed amongst properties. Then again, shareholders have little to say generally about how much CEOs of major companies are paid.

You have to decide if you are comfortable with this investment and risk, particularly when you consider where the rest of your money is invested. We’ve heard some investment advisors recommend against REITS to some retired investors when they feel that they have a significant amount of their money already tied up in real estate – their own home.