REITs, the false nirvana for yield?

[dumbstruck]

Reits are showing great yields and cap gains in this slow recovery with extended low mortgage rates. But what are the pluses and pitfalls in this environment? For example I hear there is some complex rule about holding too much REIT in an IRA can trigger a large tax which you wouldn't get if held in non-ira.

I had just doubled up on REITS, then got about a 20% crash on the new one in a couple days. I had heard a newsblurb that the US is going to lower some rather high taxes (some 1980 rule) on foreign investors on US reits. I suppose this is to reflate our market.

But now I see claims that Japan has been pursuing a dangerous scheme with bundled US reits with almost ponzi properties. They hold large percentages of US reits and have been paying their own investors huge dividends for UNREALIZED capital gains, this out of the inflows of their new investors. So I guess the prospect of this scheme blowing up and causing Japan to dump reits has jostled the market:
http://online.wsj.com/article/SB10001424127887324010704578419041839826094.html?mod=WSJ_myyahoo_module

[Tad Borek]

On 4/14/2013 3:14 PM, dumbstruck wrote:
> For example I hear there is some
> complex rule about holding too much REIT in an IRA can trigger a
> large tax which you wouldn't get if held in non-ira.

What rule is that?

-Tad

[David S Meyers CFP]

On 2013-04-14 16:14:08 +0000, dumbstruck said:

> Reits are showing great yields and cap gains in this slow recovery with
> extended low mortgage rates. But what are the pluses and pitfalls in
> this environment? For example I hear there is some complex rule about
> holding too much REIT in an IRA can trigger a large tax which you
> wouldn't get if held in non-ira.

I expect that you're referring to UBTI (or UBIT)

>From <http://www.reit.com/REIT101/REITFAQs/TaxesandREITInvestment.aspx>

> What is "Unrelated Business Taxable Income" (UBTI) and Can REIT
> Dividends Constitute UBTI? In very general terms, "unrelated business
> taxable income" (UBTI) is income earned by an otherwise tax-exempt
> entity that is considered taxable income to the entity, typically
> because it is derived from a business activity unrelated to the
> tax-exempt purpose of the entity. For example, an individual retirement
> account (IRA) is typically considered tax-exempt, but if it earns UBTI,
> it must pay tax on that income.
> In general, REIT dividends do not generate UBTI (at least no more than
> dividends from non-REIT stocks). See Revenue Ruling 66-106, in which
> the IRS specifically held that dividends from a REIT generally do not
> generate UBTI; and Revenue Ruling 2006-58, which held that a charitable
> remainder trust is not subject to unrelated business taxable income as
> a result of being allocated excess inclusion income from a REIT.
> Nevertheless, there are exceptions to the general rule, such as when a
> pension plan owns more than 25% of a REIT's stock and in the case of
> certain mortgage REITs that use financings considered to be "taxable
> mortgage pools."
In most cases, typical REIT holdings do *not* generate UBTI.

>
> I had just doubled up on REITS, then got about a 20% crash on the new
> one in a couple days. I had heard a newsblurb that the US is going to
> lower some rather high taxes (some 1980 rule) on foreign investors on
> US reits. I suppose this is to reflate our market.
>
> But now I see claims that Japan has been pursuing a dangerous scheme
> with bundled US reits with almost ponzi properties. They hold large
> percentages of US reits and have been paying their own investors huge
> dividends for UNREALIZED capital gains, this out of the inflows of
> their new investors. So I guess the prospect of this scheme blowing up
> and causing Japan to dump reits has jostled the market:
> http://online.wsj.com/article/SB10001424127887324010704578419041839826094.html?mod=WSJ_myyahoo_module
>

The biggest of the Japanese ones seem to hold as much as maybe
$1billion worth. Just the Vanguard REIT index fund alone is nearly
$20billion. It doesn't seem likely that japanese investors dumping
their REIT holdings are going to have a huge impact.

Of bigger concern, I think, is the general yield-chasing across the
board - US and otherwise - which has contributed to the huge runup in
REIT valuations and depressed true REIT yields (not the phony ones that
the Japanese funds discussed in that article are paying out). VNQ has
a recent yield of around 3.3%, very much lower than historical
patterns. When interest rates go up, one would expect yield-chasing
investors to push down the prices of REITS as well as fixed-income
securities. Take a look at this:

<http://www.vectorgrader.com/indicators/reit-dividend-yield>

It isn't clear that REITs are in a bubble, but if you compare the
price/FFO now against historical numbers, and compare that ratio to the
P/E ratio for stocks over time, you'll see that generally the S&P500
forward P/E is a good bit higher than the REIT P/FFO. Right now, by
that measure (and that's only one, single measure - there are others
worth understanding), REITs may look a little pricy.



--
David S. Meyers, CFP�
http://www.MeyersMoney.com
disclaimer: discussions in misc.invest.financial-plan are for
educational purposes only and should not be construed as financial
advice. For personal financial advice, please consult directly with a
professional.

[dumbstruck]

On Monday, April 15, 2013 8:50:02 AM UTC-10, David S Meyers CFP wrote:

> The biggest of the Japanese ones seem to hold as much as maybe
>
> $1billion worth. Just the Vanguard REIT index fund alone is nearly
>
> $20billion. It doesn't seem likely that japanese investors dumping
>
> their REIT holdings are going to have a huge impact.

Good reply all around. But maybe Japan will hit the more specialized reits, like those you buy like a stock with a ticker. I have a medical-building one that fell almost 20%, and only the Japan news seemed to be in play at the time. Others didn't fall as much, and maybe the mutual fund ones bundle a diverse group of real estate.

I did have another problem with reits many years ago. Put my IRA in a vanguard reit fund that locked up for 10 years of no early withdrawal, then it liquidated. Unlike their other reit funds, this one gambled on California commercial stuff that took a crash and shriveled my IRA during a time of high equity gains. This was disastrous as an early setback, but I recently clawed back a lot from rothifying then risky momentum trading (having little to lose in that case).