Real estate has historically been one of the primary wealth-building asset classes, but buying property directly requires significant capital, management effort, and illiquidity. REITs solve these problems by packaging real estate ownership into publicly traded securities.
For investors building portfolios of US stocks and ETFs, REITs provide real estate exposure without the complexity of direct property ownership.
What Are REITs
A real estate investment trust is a company that owns, operates, or finances income-producing real estate. Created by the US Congress in 1960, REITs give ordinary investors access to commercial real estate previously available only to wealthy individuals and institutions.
To qualify, a company must invest at least 75% of assets in real estate, derive at least 75% of gross income from rents or mortgage interest, and distribute at least 90% of taxable income as dividends. This distribution requirement is the defining feature, forcing REITs to pass most earnings directly to investors.
REITs trade on major exchanges like regular stocks, providing liquidity that direct property ownership cannot match. This combines real estate income characteristics with public market accessibility.
Types of REITs
Equity REITs
Equity REITs own and operate physical properties, collecting rent from tenants. They represent the vast majority of the REIT market. Revenue comes primarily from lease payments, and value depends on occupancy rates, rental growth, and asset appreciation.
Mortgage REITs
Mortgage REITs (mREITs) finance real estate by purchasing or originating mortgages and mortgage-backed securities. Income comes from the interest spread between borrowing costs and mortgage yields. mREITs are more sensitive to interest rate changes than equity REITs.
Hybrid REITs
Hybrid REITs combine both strategies, owning properties and holding mortgage investments. Less common, they offer diversified income across equity and debt exposure.
Sector specializations
Within equity REITs, companies specialize by property type: residential (apartments), retail (shopping centers), office, industrial (warehouses and logistics), healthcare, data centers, and cell towers.
Each responds differently to economic conditions. Industrial and data center REITs have benefited from e-commerce and cloud growth. Retail REITs have faced headwinds from online shopping.
How REITs Generate Income
Dividend yields
The 90% distribution requirement makes REITs among the highest-yielding equity investments. Average REIT dividend yields typically exceed the broader market, attracting investors seeking regular cash flow.
Rental income growth
Equity REITs grow revenue by increasing rents, improving occupancy, and acquiring properties. Well-managed REITs embed annual rent escalators in leases, providing built-in growth that can keep pace with inflation.
Property appreciation
The underlying real estate can appreciate over time. REITs in growing markets or those improving portfolios through renovations capture value appreciation reflected in share price.
Funds from operations
Traditional earnings per share is less useful for REITs because it includes depreciation on real estate assets. Funds from operations (FFO) adds back depreciation for a cleaner performance measure. Adjusted FFO further subtracts maintenance capital expenditures, representing cash truly available for distribution.
REIT Tax Considerations
Ordinary income treatment
Most REIT dividends are classified as ordinary income rather than qualified dividends. They are typically taxed at the investor's regular income tax rate, which can be higher than the preferential qualified dividend rate.
Why the difference exists
REITs avoid corporate-level taxation by distributing most earnings. The trade-off is that shareholders pay tax at ordinary income rates. The burden shifts from corporate level to individual level.
Return of capital
A portion of REIT dividends may be classified as return of capital, which is not immediately taxable. Instead, it reduces cost basis, deferring tax until shares are sold and improving tax efficiency over time.
International investor considerations
Tax treatment varies by jurisdiction. Investors outside the US may face withholding taxes on REIT dividends. Understanding implications in your specific country is important for calculating realistic after-tax returns.
Risks of REIT Investing
Interest rate sensitivity
REITs are particularly sensitive to rate changes. Rising rates increase borrowing costs and make dividend yields less attractive relative to bonds. The 2022 rate-hiking cycle caused significant REIT declines.
Sector concentration
A single REIT means exposure to one property type and often one region. Sector-specific downturns can impact individual REITs severely even when broader markets perform well.
Leverage risk
REITs commonly use debt for acquisitions. The debt-to-equity ratio varies significantly. Higher leverage amplifies gains and losses. During downturns, heavily leveraged REITs face greater risk of dividend cuts.
Occupancy and tenant risk
Revenue depends on tenants paying rent. Recessions, industry disruptions, or space oversupply can reduce occupancy and income. A REIT whose largest tenants face difficulty may see income decline even if property values hold.
Market price volatility
While publicly traded REITs offer daily liquidity, prices can be more volatile than underlying real estate values. During stress, shares may trade at significant discounts to net asset value.
Conclusion
REITs provide an accessible way to invest in real estate through public markets, combining property income characteristics with stock market liquidity. The mandatory 90% distribution requirement creates a built-in income stream that appeals to dividend-focused investors.
Successful REIT investing requires understanding the differences between equity and mortgage REITs, evaluating sector-specific trends, using FFO rather than traditional earnings for valuation, and accounting for interest rate sensitivity and tax treatment in return calculations.
If you want to start investing in US-listed REITs and REIT ETFs with fractional shares, the Gotrade app lets you build real estate exposure from as little as $1.
FAQ
What is a REIT?
A REIT is a company that owns, operates, or finances income-producing real estate and is required to distribute at least 90% of taxable income to shareholders as dividends.
Are REITs good for income investors?
Yes. The mandatory distribution requirement makes REITs among the highest-yielding equity investments, providing regular dividend income that typically exceeds broad market averages.
How are REIT dividends taxed?
Most REIT dividends are taxed as ordinary income rather than at the lower qualified dividend rate. A portion may be classified as return of capital, which defers taxation until shares are sold.
References
- Investopedia, Real Estate Investment Trust (REIT): How They Work and How to Invest, 2026.
- Nareit, What's a REIT?, 2026.
