Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing real estate and sell shares to investors. They provide a way to gain exposure to real estate without buying or managing properties directly.

Key takeaways

• REITs let investors earn income from real estate via dividends and potential share appreciation.
• To retain special tax treatment, most REITs must distribute at least 90% of taxable income as dividends.
• Main REIT categories: equity (own property), mortgage (lend on property), and hybrid (both).
• REITs are available as publicly traded shares, non-traded public offerings, private placements, and via mutual funds/ETFs.

How REITs work

REITs pool capital from many investors to buy and manage portfolios of real estate assets. They generate returns primarily from rental income (equity REITs) or interest income (mortgage REITs). Publicly traded REIT shares provide liquidity similar to stocks, making real estate more accessible and tradeable than direct property ownership.

REITs commonly specialize by property type—apartments, offices, retail, industrial (warehouses), data centers, healthcare facilities, self-storage, timberland, cell towers, etc.—though some maintain diversified portfolios.

Qualification criteria for REIT status

To qualify as a REIT under U.S. tax rules, a company must meet requirements such as:
* Invest at least 75% of total assets in real estate, cash, or U.S. Treasuries
Derive at least 75% of gross income from rent, mortgage interest, or real estate sales
Pay at least 90% of taxable income to shareholders as dividends
Be managed by a board of directors or trustees and be a taxable corporation
Have at least 100 shareholders; no more than 50% of shares owned by five or fewer individuals

Types of REITs

• Equity REITs: Own and operate income-producing real estate; revenue comes mainly from rents.
• Mortgage REITs (mREITs): Provide financing for real estate via mortgages or mortgage-backed securities; income comes from interest margins. Sensitive to interest rates.
• Hybrid REITs: Combine equity and mortgage activities (less common today).

Ways to invest in REITs

• Publicly traded REITs: Listed on stock exchanges; most liquid and accessible to individual investors.
• Public non-traded REITs: Registered with regulators but not exchange-traded; less liquid and can have longer holding periods.
• Private REITs: Not SEC-registered and typically limited to institutional or accredited investors; higher fraud risk and lower liquidity.
• REIT mutual funds and ETFs: Provide diversified exposure to many REITs in a single product; available in taxable and retirement accounts.

Practical tips for beginners

1. Start with publicly traded REITs or REIT ETFs for liquidity and transparency.
2. Do your homework: review a REIT’s property mix, management, leverage (debt-to-equity), occupancy rates, and dividend history.
3. Start small and scale up—consider allocating a modest portion of your portfolio (commonly 5–15%) to real estate depending on goals and risk tolerance.
4. Diversify across property types and geographies to reduce sector-specific risk.
5. Use REIT funds or ETFs for broad diversification and lower single-issue risk.
6. Hold REITs long term—income-oriented strategies often benefit from time in the market.
7. Stay informed about macro factors (interest rates, inflation, employment) and sector-specific trends (e.g., retail vs. industrial demand).

Tax and financial considerations

• REIT dividends are typically taxed as ordinary income rather than at lower qualified dividend rates, which can increase tax liability in taxable accounts.
• To reduce tax drag, many investors hold REITs inside tax-advantaged retirement accounts (IRAs, 401(k)s).
• REITs often use leverage; compare debt ratios to assess financial risk.
• Dividend frequency varies—many REITs pay quarterly, some monthly; frequency doesn’t guarantee performance.

Pros and cons

Pros
* Liquidity (for publicly traded REITs)
Regular income via dividends
Portfolio diversification and inflation hedge
* Professional management and access to large-scale real estate

Cons
* Dividends taxed as ordinary income in taxable accounts
Limited capacity to retain earnings (must distribute most income) which can constrain growth
Sensitive to interest rates and economic cycles
* Potentially high management or transaction fees for some non-traded or actively managed products

Common questions

Do REITs have to pay dividends?
Yes—by law most REITs must distribute at least 90% of taxable income to shareholders to maintain tax-advantaged status.

How can investors avoid REIT fraud?
Verify registration and filings through the SEC’s EDGAR system, favor regulated publicly traded REITs or established funds, and be cautious with private offerings or unsolicited pitches.

What is a “paper clip” REIT?
A paper-clip structure links two entities—one owning property and one managing it—through contractual arrangements. These structures can raise conflict-of-interest concerns and face stricter regulatory scrutiny.

Do REITs pay monthly?
Payment schedules vary. Many pay quarterly, some monthly, and a few annually. Frequency does not necessarily reflect overall return or stability.

Conclusion

REITs democratize access to commercial and large-scale real estate by enabling investors to buy shares rather than properties. They can provide steady income, diversification, and potential inflation protection, but come with tax implications, rate sensitivity, and sector-specific risks. Research individual REITs or funds, consider tax-efficient account placement, and align REIT exposure with your long-term financial goals.