How REITs Work and Why Investors Own Them

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. When you buy shares in a REIT, you own a piece of that real estate portfolio without having to buy property yourself, manage tenants, or handle repairs. The REIT collects rent from office buildings, apartments, warehouses, or shopping centers — or collects interest on real estate loans — and passes at least 90% of its taxable income to shareholders as dividends.

That dividend requirement is what makes REITs different from regular real estate companies. A typical corporation can reinvest its profits or hold cash. A REIT must distribute nearly all of it. In exchange, the REIT pays no corporate income tax on the money it distributes, so the tax burden falls on you as the shareholder. This structure makes REITs attractive to investors looking for regular income, but it also means your tax bill can be higher than it would be from stocks or bonds.

Key Takeaways

• REITs own real estate or real estate loans and must distribute at least 90% of taxable income to shareholders as dividends.
• You can buy REIT shares through a brokerage account the same way you buy stocks, and you can sell them any trading day.
• REIT dividends are taxed as ordinary income, not as capital gains, which can make your tax bill larger than with stocks.
• Different REITs focus on different property types — apartments, offices, warehouses, hospitals, data centers — so you can target specific real estate sectors.
• REITs tend to move differently than stocks during market downturns, which can make them useful for spreading risk across your portfolio.

Types of REITs and what they own

REITs fall into two broad categories: equity REITs, which own the buildings themselves, and mortgage REITs, which own loans backed by real estate. Most individual investors focus on equity REITs because they are simpler to understand — you own a share of actual property and the rent it generates.

Within equity REITs, you can find specialists in nearly every real estate category. Residential REITs own apartment buildings and single-family rentals. Industrial REITs own warehouses and logistics centers. Retail REITs own shopping centers and malls. Healthcare REITs own hospitals, medical offices, and senior living facilities. Data center REITs own the buildings that house computer servers. Office REITs own commercial office space. Each type responds differently to economic conditions — for example, a warehouse REIT may thrive during a surge in online shopping, while an office REIT may struggle if companies shift to remote work.

Mortgage REITs are more complex. Instead of owning buildings, they lend money to real estate developers and property owners, collecting interest payments. When interest rates rise, mortgage REITs can struggle because new loans pay higher rates but existing loans pay lower ones. Most beginners should start with equity REITs and learn mortgage REITs later if at all.

How to buy REIT shares

You buy REIT shares through a brokerage account — the same account you would use to buy stocks. Open an account with a broker like Fidelity, Charles Schwab, Vanguard, or any other firm that offers stock trading. Search for the REIT by its ticker symbol (a four- or five-letter code), place an order for the number of shares you want, and the transaction settles in two business days. The process is identical to buying any stock.

You can also own REITs indirectly through a mutual fund or ETF that holds multiple REITs. This approach spreads your money across many properties and property types in a single purchase. For example, the Vanguard Real Estate ETF (VNQ) holds dozens of REITs across all sectors. A mutual fund like the Vanguard Real Estate Index Fund (VGSLX) does the same thing. Many investors prefer this route because it reduces the risk that any single REIT performs poorly.

REITs trade on stock exchanges during market hours, so you can sell your shares any day the market is open. This liquidity — the ability to convert your investment to cash quickly — is a major advantage over owning physical property, which can take months to sell.

Dividends and how they are taxed

REITs are required to distribute at least 90% of taxable income to shareholders, and most distribute more. This means REIT dividends are typically much higher than stock dividends. A stock might yield 2% per year; a REIT might yield 4% or 5%. That higher payout is attractive if you need income, but it comes with a tax cost.

REIT dividends are taxed as ordinary income, the same rate as your salary or wages. They are not taxed at the lower capital gains rate that applies to stock dividends. If you are in the 24% tax bracket, a 5% REIT dividend costs you 1.2 percentage points in taxes, leaving you with 3.8% after tax. This is why many investors hold REITs in tax-advantaged accounts like IRAs or 401(k)s, where dividends are not taxed until you withdraw the money.

When you sell REIT shares for more than you paid, you owe capital gains tax on the profit, just as you would with stocks. But the regular dividends themselves carry a higher tax burden than stock dividends, so factor that into your decision about where to hold REITs in your overall portfolio.

Why investors use REITs for diversification

REITs often move independently of stocks and bonds. During a stock market crash, real estate values may hold steady or even rise if investors flee stocks and seek the safety of tangible assets. During a period of rising interest rates, REITs may fall because higher rates make borrowing more expensive and reduce the value of future rent payments — but bonds may rise. This lack of correlation means adding REITs to a portfolio of stocks and bonds can reduce overall volatility and spread risk.

Real estate also provides a hedge against inflation. When prices rise, landlords can raise rents, so REIT income tends to grow with inflation. Stocks can also benefit from inflation over time, but the relationship is less direct. Bonds suffer during inflation because the fixed payments they make are worth less in real dollars. A portfolio that includes REITs may weather inflation better than one that does not.

The diversification benefit depends on how much of your portfolio you allocate to REITs. Financial advisors often suggest 5% to 15% in real estate, though the right amount depends on your age, goals, and risk tolerance. A younger investor with decades until retirement might use less; someone nearing retirement who needs income might use more.

Risks and downsides of REIT investing

REITs are sensitive to interest rate changes. When the Federal Reserve raises rates, borrowing becomes more expensive for REITs, and the discount rate investors use to value future rent payments rises, pushing REIT prices down. Conversely, falling rates can boost REIT values. If you are uncomfortable with this interest rate sensitivity, REITs may not be right for you.

Individual REITs also carry business risk. A healthcare REIT depends on hospitals and medical offices staying profitable. A retail REIT depends on shopping centers attracting tenants. If a major tenant goes bankrupt or leaves, the REIT's income falls and its share price may drop. Diversifying across multiple REITs or holding a REIT fund reduces this risk, but does not eliminate it.

The high dividend requirement also means REITs reinvest less in growth. A typical company might use profits to expand, upgrade facilities, or develop new products. A REIT must send most of that money to you as a dividend. This can limit long-term price appreciation. If you are seeking capital growth rather than income, stocks or growth-focused funds may be a better fit.

REITs versus owning rental property directly

Buying REIT shares and buying rental property directly are not the same thing. With a REIT, you own shares in a company; you do not own the building itself. You cannot deduct mortgage interest or property taxes on your personal return. You cannot make improvements to increase value. You cannot refinance if rates drop. But you also do not have to find tenants, handle maintenance calls at 2 a.m., or manage evictions. You can sell your shares in minutes; selling a house takes months.

REITs are also more accessible. Buying a rental property requires a down payment of 20% to 25% and the ability to may have access to for a mortgage. Buying REIT shares requires only the price of one share, which might be $50 to $150. This lower barrier to entry makes real estate investing available to people who cannot afford to buy property outright.

For most investors, REITs are the simpler route to real estate exposure. If you want the full experience of being a landlord — and the tax deductions that come with it — rental property may be worth the extra work. If you want real estate in your portfolio without the headaches, REITs are the standard choice.

Frequently Asked Questions

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

No. You can buy and sell REIT shares any trading day, just like stocks. There is no minimum holding period. If you need the money, you can sell immediately. Keep in mind that selling at a loss means you cannot deduct that loss against REIT dividends you received, because the IRS treats REIT dividends as ordinary income, not capital gains.

Can I buy REITs in a retirement account?

Yes. Holding REITs in an IRA, Roth IRA, or 401(k) is actually a smart move because dividends grow tax-free inside the account. You only pay taxes when you withdraw money in retirement. This shields you from the ordinary income tax rate that normally applies to REIT dividends.

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

A REIT is a company that owns real estate. A real estate mutual fund is a fund that holds shares in multiple REITs or real estate companies. The fund gives you instant diversification across many properties and sectors in a single purchase. Most beginners find a REIT fund simpler and safer than picking individual REITs.

Do REITs pay dividends every month?

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. Monthly dividends can be convenient if you need regular income, but they do not change the total amount you receive in a year.

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

If a REIT goes bankrupt, shareholders are last in line to recover anything. Creditors and bondholders get paid first. In most cases, shareholders lose their entire investment. This is why diversifying across multiple REITs or holding a REIT fund is important — one REIT's failure will not wipe out your real estate exposure.