"My house was my best investment," brags a colleague in the doctors' lounge.

When I hear those words I think, "That doesn't say much for his ability to invest!"

The past few years have provided Southern California residents with significant appreciation in home values. However, prices in my area have dropped about 10 percent from their peak. Does that mean the real estate market is dead?

The short answer is no. Perhaps there has been a slowdown in the housing market, but the real estate market is a much broader entity. Real estate--and real estate investment trusts specifically--should be a strong consideration in investment portfolios. REITs can diversify your investments, increase returns and may be purchased from the comfort of your own living room.

When people think of real estate they usually think of the housing market, specifically their own home. The family home is a financial asset, but the entire real estate market includes apartments, offices, shopping centers, commercial buildings, storage facilities and even healthcare facilities. Unlike the family home, these entities are generally purchased for the income they provide in the form of rent. In addition, the investor commonly enjoys price appreciation if he holds the asset long term.

However, for individuals, buying one of these relatively expensive pieces of real estate may not be the best investment. If you use a large portion of your financial assets (say 50 percent) to buy an apartment building, you place yourself in potential jeopardy. You put half your eggs in one basket. As long as the building is fully rented, costs are low and the property appreciates, you will do well. However, if the neighborhood goes downhill, local job cuts occur or extensive repairs are needed, you may wind up with property that no longer provides income. It can even cost you money!

In contrast, investing in a REIT is like investing in a stock or bond. Instead of fueling a business (stocks) or loaning money (bonds), a REIT owns properties. It aims to buy real estate at reasonable prices and then manage the properties efficiently. Some REITs specialize in a particular real estate class, such as apartment buildings, shopping centers or office buildings.

REITs do the "dirty work" of managing real estate so you don't have to. You do not need to visit a potential acquisition to assess the quality of the investment. You are not required to find new tenants when the old ones move out. And best of all, no one calls you at 3 a.m. to tell you his toilet overflowed!

You can purchase individual REITs, invest in REIT mutual funds or buy managed funds in which portfolio managers move in and out of individual REITs in an effort to improve returns. REIT index funds are also available, such as the Vanguard Total REIT Index Fund. This fund includes nearly all the United States REITs, which ensures your investments are well diversified. Index funds also provide the added benefit of lower management fees. For example, the Vanguard Total REIT Index Fund charges only 0.14 percent annually whereas a REIT mutual fund typically charges an annual fee around 1 percent. The lower the management fee, the more money for the investor. The 10-year average annual return for the Vanguard REIT fund is 14.89 percent. This includes dividends and price appreciation.

A disadvantage of owning a REIT is the tax treatment of the profits. REITs are required by law to pay at least 90 percent of their profits to the investors in the form of dividends. Currently REITs pay a dividend of approximately 4 percent annually. However, unlike stock dividends that are taxed at a maximum of 15 percent by the federal government, REIT dividends are taxed like regular income. This can be as high as 35 percent on the federal level. Both stock and REIT dividends are taxed as regular income on California income tax returns. Another disadvantage of REIT ownership is that income tax on earnings cannot be deferred through depreciation in contrast to privately held property.

So when you hear a colleague boast about his home or investment property, do not be envious. You can do nearly as well by owning REITs as a part of a diversified investment portfolio. And when your colleague's tenants call him to say the water pipe broke, the lawn dried up or they moved out owing three months' rent, be glad you manage your property in a different manner--through REITs.

Paul Kirz, MD, CFP, is an orthopedic surgeon, certified financial planner and registered investment adviser. He can be reached at 562/698-7946 or PKirz@aol.com.