Reaping REITs' Rewards

The Thrift Savings Plan is fairly straightforward and TSP administrators like it that way.

The 401(k)-style retirement savings plan lets you choose from five distinct funds that invest in government securities, stocks or bonds. Then, of course, there are the TSP's new life-cycle funds. They handily mix the five existing TSP options so your money transitions from a mix of aggressive to more secure funds as you near retirement.

When some members of Congress raised the idea of adding a Real Estate Investment Trust fund to the pot, they drew a line in the sand between the lawmakers who support the bill and the TSP board, which prefers to keep the system as is: simple and cheap to maintain.

The problem, TSP board members said, is where to draw that line. Why allow one specific fund like real estate into the TSP and not others like precious commodities or socially conscious funds?

Private funds often offer upwards of 15 investment options to participants, but choice costs money. If you investigate the possibility of adding REITs, you can't simply look at a slice of the market, you have to look at all the other options, too, the TSP board has said. The five funds now in the TSP cost the government a fraction of what it would have to spend on private plans.

TSP board members assured Congress this month that they were studying the option of adding a REIT fund,and said adding an R fund was a distinct possibility. One question still remains. however: What exactly is a REIT fund and what are its pros and cons for TSP participants?

REITs are a way to invest in the real estate market outside your own four walls.

Thomas Lys, professor of accounting and real estate at Northwestern University's Kellogg School of Management, said the premise of adding a REIT option to the TSP is a sound one.

Lys explained that by law, all REIT funds are required to pay 90 percent of their income in dividends, or a distribution of a portion of a company's earnings holding. As a result, holding REITs in a taxable account means a lot of taxable income. The TSP, like similar private 401(k) plans, however, is a tax-deferred account, making it an optimal investment opportunity for REITs. TSP participants can reap the rewards of REIT funds without assuming a heavy tax burden.

Lys noted that real estate isn't always in synch with the general economy and when stocks go up or down, REITs don't have the same correlation to real estate prices. REITs can add balance to your portfolio, as a result. Lys said REITs are "somewhere in the middle between government bonds and stocks," in terms of risk.

"The minus is people think that real estate is currently overvalued," Lys said. If a REIT bill were passed by Congress tomorrow, you probably shouldn't log on to your TSP account to make changes quite so fast. Lys said that's a short-term problem, and like all investments, will change with time. It should not affect Congress' long-term policy on whether or not to include the fund.

But while diversifying the TSP is smart, according to Lys, REITs probably won't be a major boon to your account. Other than the overactive real estate market of the past few years, Lys said that on average REIT funds had a fairly low yield and would be a better investment if you were nearing retirement and looking for safer options.

According to Michael Grupe, a senior vice president at the National Association of Real Estate Investment Trusts, the TSP would be in good company if it added a REIT fund. The California and Ohio state pensions, General Motors and the Harvard Endowment allocate significant allotments to REITs.

"If diversification is a good thing for institutions, it probably is also a good thing for individuals," Grupe said.

Grupe noted, however, that a REIT fund "may be a few basis points higher" than the existing TSP funds. The TSP said its report on the viability of REIT funds will be completed around September 2006.