How a REIT Works and What It Means for Your Portfolio

What a REIT is and how it pays you

A REIT (Real Estate Investment Trust) is a company that owns buildings, land, or mortgages and distributes most of its income to shareholders. You buy shares like you would buy stock in any other company, but instead of owning a piece of a retailer or manufacturer, you own a piece of real estate holdings. The company collects rent from tenants or interest from loans, and by law must pay out at least 90 percent of its taxable income to shareholders each year.

That payout is the main reason people buy REITs. A typical REIT yields 3 to 6 percent annually, which is often higher than the dividend from a regular stock or the interest from a bond. You receive the payment quarterly, just like a dividend. The trade-off is that REIT dividends are taxed as ordinary income rather than at the lower capital gains rate, so they cost you more in taxes if held in a regular brokerage account.

REITs come in different types depending on what real estate they own. An apartment REIT owns residential buildings. A retail REIT owns shopping centers. A healthcare REIT owns hospitals and nursing homes. A data center REIT owns the server facilities that run the internet. Some REITs focus on a single property type; others own a mix. The type matters because different real estate sectors perform differently depending on the economy and interest rates.

Key Takeaways

• A REIT is a company that owns real estate or mortgages and must distribute at least 90 percent of its taxable income to shareholders each year.
• You buy and sell REIT shares on a stock exchange just like regular stock, and you receive quarterly dividend payments.
• REIT dividends are taxed as ordinary income, not capital gains, so they work better in tax-advantaged accounts like IRAs than in regular brokerage accounts.
• REITs give you exposure to real estate without buying property directly, but their share price and dividend move with interest rates and the health of the real estate market.
• Different REIT types own different property — apartments, offices, warehouses, hospitals — so you can target specific real estate sectors.

How REIT share prices move

A REIT share price changes based on two things: the value of the real estate it owns and the level of interest rates. When interest rates rise, the dividend yield of existing REITs becomes less attractive compared to bonds and savings accounts, so investors sell and prices fall. When rates fall, REITs become more attractive again and prices rise. This relationship is tighter for REITs than for regular stocks because the dividend is so central to why people own them.

The value of the underlying real estate also matters. If a REIT owns apartment buildings in a city where rents are rising and vacancy is low, the company can raise rents when leases renew, which increases income and supports a higher share price. If the same REIT owns office buildings in a city where remote work has emptied the market, rents may fall and vacancy may rise, which hurts income and the share price. You can research a REIT's occupancy rate and rent growth in its quarterly earnings reports.

Unlike a stock in a growing tech company, a REIT's share price does not typically soar. You make money mainly through the dividend, not through capital appreciation. Some investors view this as a drawback; others prefer the steady income. If you need growth, a REIT may be a smaller part of your portfolio. If you need income, it may be a larger part.

Publicly traded REITs versus non-traded REITs

Most REITs trade on a stock exchange — the New York Stock Exchange or NASDAQ — just like regular stocks. You can buy and sell shares during market hours through any brokerage account. These are called publicly traded REITs. Their prices change minute by minute, and you always know what your shares are worth.

Non-traded REITs do not trade on an exchange. They are sold directly by the sponsor, usually through a financial advisor, and you cannot easily sell your shares. The sponsor sets the price, which is updated quarterly or annually. Non-traded REITs often charge higher fees and take longer to return your money if you need to exit. They are marketed as less volatile because the price does not move daily, but that is partly because you cannot see the price move — the underlying real estate value is still changing. Most individual investors are better served by publicly traded REITs because of the liquidity and lower costs.

Where to hold a REIT in your account

Because REIT dividends are taxed as ordinary income, they work best in tax-advantaged accounts. If you hold a REIT in a traditional IRA or Roth IRA, you avoid the annual tax bill on the dividend. The dividend stays in the account and compounds. If you hold the same REIT in a regular brokerage account, you owe income tax on the dividend every year, which reduces the amount you have left to reinvest.

This does not mean you should never hold a REIT in a regular account. If you have maxed out your IRA contributions and want more real estate exposure, a taxable account is the only option. Just be aware that the tax drag is real. Some investors use a strategy called tax-loss harvesting — selling a REIT at a loss to offset gains elsewhere — to reduce the tax impact, but this requires active management.

How to evaluate a REIT before buying

Start with the dividend yield and the payout ratio. The yield tells you what percentage return you are getting from the dividend. The payout ratio tells you what percentage of the REIT's funds from operations (FFO) it is distributing. If the payout ratio is above 100 percent, the REIT is paying out more than it earns, which is unsustainable. A ratio between 60 and 80 percent is healthy because it leaves room for maintenance, debt service, and growth.

Next, look at occupancy and rent growth. A REIT's quarterly earnings report includes the occupancy rate (what percentage of units are rented) and same-store rent growth (how much rents rose on properties the REIT owned in both periods). High occupancy and positive rent growth suggest the REIT is in a strong market. Falling occupancy or negative rent growth is a warning sign.

Finally, check the debt level. REITs use leverage to buy more property, which can amplify returns but also amplifies losses. Look at the debt-to-EBITDA ratio (how many years of earnings it would take to pay off the debt). A ratio above 6 or 7 is high; below 4 is conservative. The REIT's management discussion in the quarterly report will explain the debt strategy and any refinancing risks.

REITs in a diversified portfolio

Real estate is a separate asset class from stocks and bonds, so adding a REIT can reduce overall portfolio risk through diversification. A portfolio of stocks, bonds, and REITs tends to be less volatile than a portfolio of just stocks and bonds because real estate does not move in lockstep with either. However, REITs are not a substitute for diversification within stocks — you still need exposure to different industries and company sizes.

A common allocation is 5 to 15 percent in REITs, depending on your age and goals. Younger investors with a long time horizon may use the lower end because they can afford to take more stock risk. Investors closer to retirement or those who need current income may use the higher end. You can own individual REITs or buy a REIT index fund or ETF that holds dozens of REITs across different property types, which spreads the risk.

Frequently Asked Questions

Do I need a lot of money to invest in a REIT?

No. You can buy a single share of a publicly traded REIT for the price of one share, which ranges from under $10 to over $100 depending on the REIT. You can also buy a REIT mutual fund or ETF with as little as $1,000 or even less, depending on the fund. Non-traded REITs typically require a minimum investment of $2,500 to $25,000.

Can I lose money in a REIT?

Yes. The share price can fall if interest rates rise, if the real estate market weakens, or if the specific REIT mismanages its properties or takes on too much debt. You can also lose money if you sell during a downturn. The dividend is not may provide, though REITs are required by law to distribute most of their income, so cuts are less common than with regular stock dividends.

What is the difference between a REIT and a real estate mutual fund?

A REIT is a company that owns real estate directly. A real estate mutual fund is a fund that owns shares in multiple REITs or real estate companies. A REIT fund gives you diversification across many REITs and property types with a single purchase, whereas buying one REIT gives you exposure to one company's specific properties and strategy.

Should I hold REITs in a Roth IRA?

Yes, if you have room. Because REIT dividends are taxed as ordinary income, a Roth IRA is an ideal place to hold them. The dividend grows tax-free, and you pay no tax on withdrawals in retirement. A traditional IRA also works, but you will owe income tax on withdrawals.

How often do REITs pay dividends?

Most REITs pay dividends quarterly, though some pay monthly or annually. Check the REIT's investor relations page or your brokerage statement to see the payment schedule. Quarterly is the most common.