How Real Estate Investment Trusts Work and Why Investors Own Them
What a REIT is and how it works
A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances real estate — office buildings, apartments, shopping centers, warehouses, hospitals, data centers. Instead of buying property yourself, you buy shares in the REIT, and the REIT's income from rent and property sales flows back to you as a shareholder.
REITs exist because of a tax rule: if a company owns real estate and distributes at least 90 percent of its taxable income to shareholders each year, it does not pay corporate income tax. That income passes through to you instead. In exchange, the REIT must have at least 100 shareholders, at least 75 percent of its assets in real estate, and at least 75 percent of its income from real estate rents or mortgages.
When you own REIT shares, you own a piece of the underlying properties without managing tenants, repairs, or mortgages yourself. The REIT's management team handles that work. You receive income through dividends — usually paid quarterly — and you can sell your shares whenever you want if the REIT is publicly traded.
Key Takeaways
- A REIT is a company that owns real estate and must distribute 90 percent of its taxable income to shareholders, which is why REIT dividends tend to be higher than stock dividends.
- You can buy REIT shares through a brokerage account the same way you buy stocks, and publicly traded REITs are liquid — you can sell them any trading day.
- REITs own different types of property: residential apartments, office buildings, retail centers, industrial warehouses, healthcare facilities, and data centers, so you can choose the sector that fits your portfolio.
- REIT dividends are taxed as ordinary income, not as capital gains, which means the tax bill is usually higher than it would be for stock dividends.
Types of property REITs own
REITs specialize in different real estate sectors, and each sector has different income patterns and risks. A residential REIT owns apartment buildings and collects rent from tenants. An office REIT owns commercial office space and leases it to companies. A retail REIT owns shopping centers and strip malls. An industrial REIT owns warehouses and distribution centers, often leasing to e-commerce companies.
Healthcare REITs own hospitals, medical office buildings, and senior living facilities. Data center REITs own the buildings that house servers for cloud computing and internet services. Specialty REITs own things like cell towers, billboard space, or self-storage units. Some REITs are diversified and own multiple property types; others focus on a single sector.
The property type matters because it affects how stable the income is and how the REIT performs during economic downturns. Residential and healthcare REITs tend to be more defensive — people need housing and medical care in any economy. Retail and office REITs are more sensitive to recessions because businesses cut back on space when revenue falls.
How REIT dividends work and what you receive
REITs must distribute at least 90 percent of their taxable income to shareholders, so REIT dividends are typically much higher than the dividend yield on a regular stock. A REIT might pay 3 to 6 percent annually, while the average stock dividend is closer to 1 to 2 percent. That higher payout is the main reason investors buy REITs.
The dividend comes from the REIT's rental income minus operating costs — property taxes, maintenance, property management, insurance, and mortgage payments. If the REIT sells a property at a profit, some of that gain flows to shareholders too. Most REITs pay dividends quarterly, and many allow you to reinvest dividends automatically to buy more shares.
One important catch: REIT dividends are taxed as ordinary income, not as may have access to dividends or capital gains. That means if you own a REIT in a taxable account, you pay your full income tax rate on the dividend, which can be significantly higher than the 15 or 20 percent rate on stock capital gains. Holding REITs in a tax-deferred account like an IRA or 401(k) can reduce that tax burden.
Public REITs versus private REITs
A publicly traded REIT is listed on a stock exchange — the New York Stock Exchange or NASDAQ — and you can buy shares through any brokerage account. Prices change throughout the trading day based on supply and demand. You can sell whenever you want, and the transaction settles in two business days. Examples include Realty Income, Prologis, and Welltower.
A private REIT is not listed on an exchange and is sold directly to investors, usually through financial advisors or broker-dealers. You cannot sell a private REIT share on a public market, so your money is locked in. Private REITs often have higher minimum investments — sometimes $25,000 or more — and they charge higher fees. They also provide less transparency because they report less frequently to regulators.
Most individual investors buy public REITs because they are liquid, transparent, and easy to trade. Private REITs are typically used by wealthy investors or as part of a professionally managed portfolio. If you are building your own portfolio, stick with public REITs unless a financial advisor has a specific reason to recommend a private one.
How REIT prices move and what affects them
REIT share prices move based on two things: the income the REIT generates and interest rates. When a REIT raises its dividend or reports higher occupancy rates and rents, the share price usually rises. When a REIT cuts its dividend or reports vacancies, the price falls.
Interest rates have an outsized effect on REIT prices. REITs borrow money to buy property, so when interest rates rise, their borrowing costs go up and their profits shrink. Higher rates also make bonds and savings accounts more attractive relative to REIT dividends, so investors sell REIT shares to buy those safer investments. The opposite happens when rates fall — REIT prices tend to rise because borrowing becomes cheaper and dividend yields look more attractive.
Economic recessions also matter. During a recession, tenants may default on rent or move out, and the REIT's income falls. Office and retail REITs suffer more than residential or healthcare REITs. If you own a REIT, expect the share price to drop during a downturn even if the dividend holds steady.
REITs in a diversified portfolio
REITs serve a specific role in a portfolio: they provide higher income than stocks and they move somewhat independently of the stock market. When stocks fall, REITs sometimes hold up better because real estate is a tangible asset and rental income is steady. That diversification benefit is why many investors hold 5 to 15 percent of their portfolio in REITs.
You can own REITs directly by buying individual REIT shares, or you can own them through a mutual fund or exchange-traded fund (ETF) that holds multiple REITs. A REIT mutual fund or ETF spreads your risk across many properties and sectors, which is simpler than picking individual REITs. Examples include Vanguard Real Estate ETF and iShares U.S. Real Estate ETF.
The choice between individual REITs and a REIT fund depends on how much time you want to spend researching. If you want to own a specific REIT because you believe in its management or its property type, buy individual shares. If you want broad real estate exposure without picking winners, buy a REIT fund.
Risks and downsides of REIT ownership
REITs are not risk-free. Interest rate increases hurt REIT prices and reduce future dividend growth. Economic recessions reduce occupancy and rental income. Natural disasters, tenant defaults, or unexpected maintenance costs can squeeze profits. Some REITs take on too much debt and struggle to pay dividends if income falls.
The tax treatment of REIT dividends is also a downside in taxable accounts. Because dividends are taxed as ordinary income rather than capital gains, your after-tax return is lower than it appears. A REIT yielding 5 percent might deliver only 3 percent after taxes if you are in a high tax bracket. This is one reason to hold REITs in retirement accounts when possible.
REIT share prices are also volatile. Even though the underlying real estate is stable, REIT stock prices can swing 20 to 30 percent in a year based on interest rate changes and investor sentiment. If you need the money in the next few years, that volatility can hurt you.
Frequently Asked Questions
Can I buy REIT shares in a retirement account?
Yes. Holding REITs in an IRA, Roth IRA, or 401(k) is actually a smart move because REIT dividends are taxed as ordinary income. In a retirement account, you avoid that tax hit until you withdraw money. This makes retirement accounts an ideal place for high-dividend investments like REITs.
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 properties and sectors with one purchase, while owning individual REIT shares gives you more control but requires more research.
Do REITs pay dividends every month?
Most REITs pay dividends quarterly, though some pay monthly or semi-annually. Check the REIT's investor relations page or your brokerage statement to see the payment schedule. Monthly dividend REITs are popular with income-focused investors, but the payment frequency does not affect total annual return.
What happens to my REIT shares if the company goes bankrupt?
If a REIT files for bankruptcy, shareholders are last in line to recover money — creditors and bondholders are paid first. You could lose your entire investment. This is why it matters to check a REIT's debt levels and credit rating before buying. REITs with lower debt and strong cash flow are safer.
Can I lose money on a REIT if I hold it long-term?
Yes. If interest rates stay high or the real estate market weakens, a REIT's share price can remain depressed for years. You can also lose money if the REIT cuts its dividend, which signals financial trouble. Long-term holding reduces timing risk but does not eliminate the risk that the REIT itself performs poorly.