How a REIT Generates Income and Passes It to Shareholders

A REIT buys and manages real estate, then distributes most of its rental income to you as a shareholder

A Real Estate Investment Trust (REIT) works like this: the REIT borrows money and buys buildings — office towers, apartment complexes, shopping centers, warehouses, data centers, or hospitals. Tenants pay rent. The REIT collects that rent, pays the mortgage and operating costs, and sends most of what's left to shareholders like you as distributions (similar to dividends). You own a small piece of the real estate without buying a building yourself or becoming a landlord.

The reason REITs exist is a tax rule: if a REIT distributes at least 90 percent of its taxable income to shareholders each year, the REIT itself pays no corporate income tax. That income gets taxed only once — at the shareholder level — instead of twice (once at the company, once at you). This structure makes REITs attractive to investors who want real estate exposure without the work of owning property directly.

You buy REIT shares the same way you buy stock: through a brokerage account. You can sell them whenever the market is open. Some REITs are publicly traded on exchanges like the NYSE; others are private and harder to buy or sell. The price of a REIT share moves based on what investors think the underlying real estate is worth and what income it will generate.

Key Takeaways

• A REIT owns and manages real estate, collects rent from tenants, and distributes at least 90 percent of its income to shareholders each year.
• You buy REIT shares through a brokerage account and can sell them like stock, though some REITs are private and less liquid.
• REIT distributions are taxed as ordinary income to you, not as capital gains, which can make them less tax-efficient in taxable accounts.
• Different REITs focus on different property types — apartments, offices, retail, warehouses, data centers, or healthcare facilities — so you can target specific real estate sectors.
• A REIT's share price can fall if interest rates rise, property values drop, or tenants stop paying rent, just as with any investment.

How a REIT generates money to distribute

The REIT's income comes from rent. When a tenant signs a lease for office space or an apartment, they pay monthly rent to the REIT. The REIT collects thousands or millions of dollars in rent each month depending on how many properties it owns and how full they are.

From that rent, the REIT pays operating expenses: property taxes, insurance, maintenance, utilities, property management salaries, and debt service (interest and principal on loans). What remains is net operating income. The REIT then distributes most of this to shareholders. If a REIT owns a $100 million apartment building that generates $8 million in annual rent and costs $3 million to operate, it has $5 million to distribute. Shareholders split that $5 million based on how many shares they own.

Some REITs also make money by selling properties at a profit or by refinancing debt at lower rates. But the core business is collecting rent and passing it through.

The difference between REIT distributions and stock dividends

When you own stock in a regular company, dividends are usually taxed as capital gains (often at lower rates). REIT distributions are taxed as ordinary income, the same as wages or interest. This matters in a taxable brokerage account: if you earn $5,000 in REIT distributions, you owe tax on that $5,000 at your full income tax rate, not the lower capital gains rate.

Because of this tax treatment, many investors hold REITs in tax-advantaged accounts like IRAs or 401(k)s, where distributions are not taxed each year. In a taxable account, the tax drag can be significant if the REIT has a high distribution yield (meaning it pays out a large percentage of the share price each year).

The other difference: REIT distributions are required by law. A regular company can cut its dividend whenever it wants. A REIT must distribute at least 90 percent of taxable income or lose its REIT status and face corporate taxes. This makes REIT distributions more predictable but also means the REIT has less flexibility to reinvest earnings or weather downturns.

What happens to the share price when interest rates change

REIT share prices are sensitive to interest rates. Here's why: when the Federal Reserve raises interest rates, new bonds and savings accounts pay higher yields. Investors can now earn 5 percent in a money market fund instead of 2 percent. A REIT that pays a 4 percent distribution suddenly looks less attractive by comparison. Investors sell REIT shares to buy bonds, and the REIT's share price falls.

The reverse happens when rates fall. A REIT paying 4 percent becomes more attractive than a bond paying 2 percent, so investors buy REIT shares and the price rises.

This interest-rate sensitivity is one reason REITs can be volatile. The underlying real estate may be stable and generating steady rent, but the share price swings based on what investors can earn elsewhere. A rising-rate environment is often tough for REITs; a falling-rate environment is often good for them.

Different types of REITs focus on different properties

REITs specialize. Some own only apartments (residential REITs). Others own only office buildings, shopping centers, warehouses, data centers, or hospitals. A few own a mix. This specialization matters because different property types have different economics and risks.

An apartment REIT benefits when housing demand is strong and rents rise. An office REIT suffered after the pandemic when companies let employees work from home and needed less office space. A warehouse REIT thrived as e-commerce grew. A healthcare REIT owns medical office buildings and senior housing, which are less sensitive to economic cycles.

When you buy a REIT, you are betting on both the REIT's management and the sector it operates in. A well-run apartment REIT in a weak housing market can still underperform. A mediocre warehouse REIT in a strong e-commerce environment can outperform. Understanding what the REIT owns is the first step to understanding its risks.

Leverage: why REITs borrow money

Most REITs borrow heavily. A REIT might own $100 million in real estate but finance $60 million of it with debt, putting up only $40 million in equity. This leverage amplifies returns when things go well: if the real estate appreciates 10 percent, the equity grows 16.7 percent (because the gain applies to the full $100 million but is split among only $40 million in equity). But leverage also amplifies losses.

When interest rates rise, a REIT's borrowing costs increase. If a REIT refinances a $50 million loan at a higher rate, its interest expense climbs and distributions may fall. This is another reason REITs are sensitive to rate changes: not only do investors demand higher yields, but the REIT's own costs rise.

A REIT with high leverage (a lot of debt relative to equity) is riskier than one with low leverage. In a downturn, a highly leveraged REIT might struggle to pay its debt. This is why investors watch a REIT's debt-to-equity ratio and interest coverage ratio (how many times over the REIT can cover its interest payments with operating income).

How REIT performance differs from owning property directly

Owning a REIT share is not the same as owning a rental property. When you own a rental house, you control the property, can make improvements, and keep all the profit. You also handle tenants, repairs, and taxes yourself. A REIT removes that work: professional managers handle everything. But you also give up control and must accept whatever decisions management makes.

REIT shares are liquid: you can sell them in minutes during market hours. A rental property can take months to sell. REIT shares are divisible: you can own a fraction of a building by owning one share. A rental property is not. But REIT shares fluctuate in price daily based on investor sentiment; a rental property's value is more stable (though harder to measure).

A REIT also provides instant diversification. One REIT share might give you exposure to dozens of properties across multiple cities. Owning one rental property gives you exposure to one property in one location. For most investors, a REIT is a more practical way to own real estate.

Frequently Asked Questions

Do I have to hold a REIT for a certain amount of time?

No. You can buy and sell REIT shares whenever you want, just like stock. There are no holding periods or penalties for selling early. The only cost is the trading commission (if your broker charges one) and any capital gains tax owed if you sell at a profit.

What happens to my REIT shares if the company goes bankrupt?

You lose your investment. Shareholders are last in line: creditors and bondholders get paid first. However, REIT bankruptcies are rare because the underlying real estate usually has value and can be sold or refinanced. The bigger risk is a sharp drop in share price if the REIT struggles, not total loss.

Can I reinvest REIT distributions to buy more shares?

Yes. Most brokerages offer a dividend reinvestment plan (DRIP) that automatically uses your distributions to buy more REIT shares. This can amplify your returns over time through compounding, though you still owe tax on the distributions each year.

Are REIT distributions the same every quarter?

Not necessarily. While REITs must distribute 90 percent of taxable income, the amount can vary if the REIT's income changes. If occupancy drops or a major tenant leaves, distributions may fall. Some REITs try to keep distributions stable by drawing on reserves, but this is not may provide.

Should I buy individual REITs or a REIT mutual fund?

A REIT mutual fund or ETF gives you exposure to many REITs across different sectors with one purchase, reducing the risk that one REIT underperforms. Individual REITs let you target specific sectors but require more research. Most investors benefit from a fund unless they have strong conviction about a particular REIT or sector.