How Real Estate Investment Trusts Work and Why Investors Own Them

What a REIT is and how it works

A Real Estate Investment Trust is a company that owns, operates, or finances income-producing real estate — apartment buildings, office parks, shopping centers, warehouses, hotels, or data centers. Instead of buying property yourself, you buy shares in the REIT, and the company's profits from rents and property sales flow back to you as a shareholder.

REITs exist because of a tax rule: if a company owns real estate, collects rent, and distributes at least 90 percent of its taxable income to shareholders each year, it pays no corporate income tax. That income is taxed once, at the shareholder level, rather than twice. This structure makes it cheaper for the REIT to operate, and that savings gets passed to you.

You buy REIT shares the same way you buy stock — through a brokerage account, on a stock exchange. A share price moves up and down based on what other investors will pay for it. You also receive distributions (similar to dividends) from the REIT's rental income, usually quarterly. Some REITs reinvest profits into new properties; others prioritize high distributions to shareholders.

Key Takeaways

• A REIT is a company that owns real estate and distributes at least 90 percent of its taxable income to shareholders each year, which is why the distributions tend to be higher than stock dividends.
• You own shares in a REIT through a brokerage account, not the property itself, so you have no maintenance costs, tenant problems, or property management duties.
• REIT shares trade on stock exchanges during market hours, meaning you can sell quickly, unlike physical real estate which takes months to sell.
• Different REITs own different property types — residential, commercial, industrial, healthcare — so you can target the real estate sector you want exposure to.
• REIT distributions are taxed as ordinary income, not capital gains, so they may create a larger tax bill than stock dividends in a taxable account.

Types of REITs and what they own

REITs are divided by the type of property they own. A residential REIT might own apartment complexes or single-family rental homes. A commercial REIT owns office buildings or retail space. An industrial REIT holds warehouses and logistics centers. A healthcare REIT owns medical office buildings, senior housing, or hospitals. A data center REIT owns the physical buildings that house servers.

Some REITs focus on a single property type; others diversify across several. A diversified REIT might own apartments, office space, and retail in different regions. The property type matters because different sectors perform differently depending on economic conditions — office REITs struggled during the pandemic shift to remote work, while industrial REITs thrived as e-commerce demand surged.

You can also find mortgage REITs, which don't own property at all. Instead, they lend money to real estate developers or buy mortgages backed by commercial property. Mortgage REITs behave differently from property-owning REITs and carry different risks, so they are worth understanding separately if you are considering them.

How REIT returns work: distributions and share price

Your return from a REIT comes from two sources: distributions and share price appreciation. Distributions are the quarterly or annual payouts from the REIT's rental income and property sales. Because REITs must distribute 90 percent of taxable income, distributions are often higher than the dividends you would get from a typical stock. A REIT might distribute 3 to 6 percent of its share price annually, though this varies widely by REIT and market conditions.

The share price itself can rise or fall based on investor demand, interest rates, and the REIT's property values. If a REIT owns properties in a hot real estate market, or if interest rates fall and make real estate more attractive, the share price may climb. If the REIT reports weak rental income or property values decline, the share price may drop. You can sell your shares at any time during market hours, locking in a gain or loss.

The combination matters. A REIT with a 4 percent distribution yield and a share price that rises 2 percent in a year gives you a 6 percent total return. A REIT with a 5 percent distribution but a falling share price might deliver only a 2 percent total return, or even a loss if the price falls more than 5 percent.

Why investors use REITs instead of owning property directly

Buying an apartment building or office park requires hundreds of thousands of dollars upfront, a mortgage application, property inspections, and ongoing management. You become responsible for tenant disputes, maintenance, vacancies, and property taxes. REITs let you own real estate exposure with a few hundred dollars and no landlord duties.

REITs also offer liquidity. If you own a rental property and need cash, you must list it, wait for a buyer, and close — a process that takes months. REIT shares sell in seconds during market hours. This speed matters if your circumstances change or you want to rebalance your portfolio.

Diversification is another advantage. Buying multiple properties across different cities and property types requires millions of dollars. A REIT lets you own a piece of dozens or hundreds of properties with a small investment. You get geographic and sector diversification that would be impossible to build alone.

Tax treatment of REIT distributions

REIT distributions are taxed as ordinary income, not capital gains, even though they come from property ownership. This is a key difference from stock dividends, which often may have access to for lower capital gains tax rates. If you hold a REIT in a taxable brokerage account, you will owe income tax on distributions at your regular tax rate — potentially 22 percent, 24 percent, or higher depending on your income.

This tax treatment makes REITs more efficient in tax-advantaged accounts like IRAs or 401(k)s, where distributions are not taxed until you withdraw money. Many investors hold REITs in retirement accounts for this reason and keep stocks or bonds in taxable accounts instead.

When you sell REIT shares at a profit, you owe capital gains tax on the gain, just as you would with stock. If you hold the shares for more than one year, the gain qualifies for long-term capital gains rates, which are lower than ordinary income rates.

Risks specific to REITs

REITs are sensitive to interest rates. When the Federal Reserve raises rates, borrowing becomes more expensive for REITs that use debt to buy property. Higher rates also make bonds and savings accounts more attractive to investors, so money flows away from REITs. Conversely, falling rates boost REIT valuations. If you own REITs, interest rate changes will affect your returns.

REITs also depend on economic conditions. A recession reduces office occupancy, retail traffic, and hotel bookings, which lowers rental income and REIT share prices. A REIT that owns office space in a city losing jobs faces particular pressure. Property-specific risks matter too — a REIT that owns shopping malls faces long-term headwinds from e-commerce, while a data center REIT benefits from cloud computing growth.

Leverage is another consideration. Many REITs borrow money to buy more property, which amplifies returns in good times but increases losses in downturns. A REIT with high debt is riskier than one with low debt, especially if interest rates rise or the economy weakens.

How to buy REIT shares and build a REIT position

You buy REIT shares through a brokerage account — the same account you would use to buy stock. Open an account with a broker like Fidelity, Vanguard, Charles Schwab, or another firm, fund it, and search for the REIT by its ticker symbol. Place a buy order just as you would for any stock. The transaction settles in two business days, and you own the shares.

You can buy individual REITs if you want to target specific property types or markets. You can also buy REIT mutual funds or exchange-traded funds (ETFs) that hold a basket of REITs, which gives you instant diversification. A REIT ETF might hold 50 or 100 different REITs across property types and regions, reducing the risk that any single REIT underperforms.

Many investors use REITs as a small part of a diversified portfolio — perhaps 5 to 15 percent of their holdings — to add real estate exposure without the complexity of direct ownership. Others focus on REITs as their primary real estate strategy. Your allocation depends on your goals, time horizon, and risk tolerance.

Frequently Asked Questions

Do I have to hold a REIT for a minimum time?

No. You can sell REIT shares anytime during market hours, just like stock. There is no holding period requirement. However, if you sell within one year of buying, any gain is taxed as short-term capital gains at your ordinary income tax rate rather than the lower long-term rate.

Can I lose money in a REIT?

Yes. REIT share prices fall when interest rates rise, when the economy weakens, or when the REIT's properties lose value or occupancy. You can also lose money if you sell shares at a lower price than you paid. Distributions do not may provide a return.

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 owns shares in multiple REITs or real estate companies. A REIT fund gives you diversification across many REITs with one purchase, while buying individual REIT shares lets you pick specific properties or sectors.

Should I hold REITs in a regular brokerage account or a retirement account?

Retirement accounts are usually better because REIT distributions are taxed as ordinary income. In an IRA or 401(k), you avoid that tax until withdrawal. In a taxable account, you owe income tax on distributions every year, which reduces your after-tax return.

How often do REITs pay distributions?

Most REITs pay distributions quarterly, though some pay monthly or annually. The frequency varies by REIT. You can find the distribution schedule on the REIT's investor relations website or through your brokerage.