REIT (Real Estate Investment Trust): What It Is & How It Works
How REITs Work
Congress created REITs in 1960 to give everyday investors access to large-scale commercial real estate, much the way mutual funds give access to diversified stock portfolios. The structure works like this: a REIT pools investor capital to acquire or finance real estate assets, collects rent or interest income, and passes most of that income through to shareholders.
To qualify as a REIT under IRS rules, a company must meet several requirements:
| Requirement | Details |
|---|---|
| Income distribution | Must pay out ≥90% of taxable income as dividends annually |
| Asset composition | ≥75% of total assets must be in real estate, cash, or U.S. Treasuries |
| Income sources | ≥75% of gross income must come from rent, mortgage interest, or real estate sales |
| Shareholder structure | Must have ≥100 shareholders; no 5 or fewer individuals can own >50% of shares |
| Entity type | Must be structured as a corporation, trust, or association |
Because REITs distribute nearly all income, they pay little to no corporate income tax at the entity level. The trade-off: they retain less cash for growth, making them more reliant on external capital (debt or new share issuance) to fund acquisitions and development.
Types of REITs
| REIT Type | What It Does | Income Source |
|---|---|---|
| Equity REIT | Owns and operates physical properties | Rental income from tenants |
| Mortgage REIT (mREIT) | Finances real estate through mortgages or mortgage-backed securities | Interest income on loans |
| Hybrid REIT | Combines both — owns properties and holds mortgages | Rent + interest income |
Equity REITs account for roughly 90% of the REIT market by market cap. They’re what most people mean when they say “REIT.” Mortgage REITs are a very different animal — they behave more like financial companies, with returns driven by interest rate spreads rather than property fundamentals.
REIT Property Sectors
Equity REITs specialize across a wide range of property types:
| Sector | Examples | Key Drivers |
|---|---|---|
| Residential | Apartment buildings, single-family rentals, manufactured housing | Population growth, housing affordability, rent trends |
| Industrial | Warehouses, distribution centers, logistics facilities | E-commerce growth, supply chain demand |
| Data Centers | Server farms, colocation facilities | Cloud adoption, AI compute demand |
| Healthcare | Hospitals, senior living, medical offices | Aging demographics, healthcare spending |
| Retail | Shopping centers, malls, net lease properties | Consumer spending, tenant creditworthiness |
| Office | Class A towers, suburban office parks | Employment trends, remote work dynamics |
| Specialty | Cell towers, self-storage, timber, casinos | Varies by niche |
Key REIT Metrics
REITs are valued differently from regular stocks because standard earnings metrics don’t reflect real estate economics well. Depreciation — a large non-cash expense — artificially depresses net income for property-owning companies. The industry uses its own metrics:
| Metric | Formula | What It Measures |
|---|---|---|
| FFO (Funds From Operations) | Net Income + Depreciation − Gains on Property Sales | Core operating cash flow — the REIT equivalent of earnings |
| AFFO (Adjusted FFO) | FFO − Recurring CapEx − Leasing Costs | A tighter measure of sustainable cash flow available for dividends |
| Cap Rate | Net Operating Income ÷ Property Value | Yield on the underlying property — used to value individual assets |
| NAV (Net Asset Value) | Estimated value of properties − debt | What the REIT’s assets are worth if sold — used to spot premiums/discounts |
| Dividend Yield | Annual Dividend ÷ Share Price | Current income return to shareholders |
| Occupancy Rate | Leased Space ÷ Total Available Space | How full the portfolio is — a fundamental health indicator |
How to Invest in REITs
| Method | Access | Considerations |
|---|---|---|
| Publicly traded REITs | Buy shares on stock exchanges like any stock | Liquid, transparent, subject to stock market volatility |
| REIT ETFs / mutual funds | Broad or sector-specific REIT exposure in one ticker | Diversified; low minimum investment; ongoing expense ratio |
| Non-traded REITs | Sold through brokers; not listed on exchanges | Illiquid, high fees, limited transparency — use caution |
| Private REITs | Accredited investors only | No SEC reporting; highest risk, lowest liquidity |
REITs vs. Direct Real Estate
| Factor | REITs | Direct Property Ownership |
|---|---|---|
| Liquidity | High — sell shares instantly on exchange | Very low — selling property takes weeks to months |
| Minimum investment | Price of one share (often $20–$200) | Typically $50K+ down payment |
| Diversification | One REIT may own 100+ properties across regions | Concentrated in one or a few properties |
| Management | Fully passive — professional management handles everything | Active — maintenance, tenants, repairs (unless you hire a manager) |
| Leverage control | No control — the REIT sets its debt level | You choose your mortgage and leverage |
| Tax benefits | Limited — dividends taxed as ordinary income | Depreciation, 1031 exchanges, mortgage interest deductions |
Key Takeaways
- REITs own or finance income-producing real estate and must distribute ≥90% of taxable income as dividends.
- Equity REITs (property owners) make up ~90% of the market; mortgage REITs are a separate, more rate-sensitive category.
- Use FFO and AFFO — not standard EPS — to evaluate REIT earnings and valuation.
- Publicly traded REITs offer liquid, low-minimum real estate exposure; non-traded and private REITs carry higher fees and illiquidity risk.
- REIT dividends are mostly taxed as ordinary income — consider holding them in tax-advantaged accounts.
Frequently Asked Questions
What is a REIT in simple terms?
A REIT is a company that makes money from real estate — by owning buildings and collecting rent, or by financing real estate and earning interest — and passes most of that income to shareholders as dividends. It lets you invest in real estate without buying property yourself.
Are REITs a good investment?
REITs can be a solid component of a diversified portfolio. They provide income through high dividend yields, offer real estate exposure without the hassle of property management, and have historically delivered competitive total returns. However, they’re sensitive to interest rate changes and their dividends face higher tax rates than qualified dividends.
How are REIT dividends taxed?
Most REIT dividends are classified as ordinary income and taxed at your marginal income tax rate — not the lower qualified dividend rate. A 20% pass-through deduction applies through 2025, which helps offset the higher rate. Holding REITs in a tax-advantaged account (IRA, 401(k)) avoids the tax drag entirely on dividends.
What is the difference between a REIT and a real estate ETF?
A REIT is a single company that owns real estate. A real estate ETF is a fund that holds shares of many REITs, giving you diversified exposure across dozens or hundreds of REITs in one ticker. The ETF adds a layer of diversification but also charges its own expense ratio.
Do REITs do well when interest rates rise?
REITs tend to underperform in the short term when rates rise sharply, because higher rates increase borrowing costs and make bond yields more competitive with REIT dividends. However, if rates are rising due to a strong economy, growing rents and occupancy can offset the interest rate headwind over time. The long-term track record of REITs through rising rate periods is more nuanced than the “rates up, REITs down” narrative suggests.