REITs can work for some investors, but they are not right for everyone

A Real Estate Investment Trust (REIT) is a company that owns or finances income-producing real estate — apartment buildings, office parks, shopping centers, warehouses, hospitals. When you buy shares in a REIT, you own a piece of that real estate portfolio without buying property yourself. The company collects rent, manages the buildings, and must distribute at least 90 percent of its taxable income to shareholders as dividends.

Whether a REIT is a good investment depends on your financial situation, how much risk you can handle, and what you are trying to accomplish. REITs offer some real advantages — diversification, regular income, lower entry cost than buying property — but they also carry drawbacks that matter: higher taxes on dividends, sensitivity to interest rates, and volatility in share price.

Key Takeaways

  • REITs must distribute 90 percent of taxable income to shareholders, which creates regular dividend payments but also means those dividends are taxed as ordinary income, not capital gains.
  • REIT share prices move with stock market conditions and interest rates, so they are not as stable as owning physical property outright.
  • REITs let you invest in real estate with a small amount of money and without managing tenants or repairs yourself.
  • Different types of REITs focus on different property — residential, commercial, industrial, healthcare — so your choice depends on what real estate sector you want exposure to.

How REIT dividends and taxes work

REITs are required by law to pay out most of their income, which means you receive regular dividend checks. The amount varies by REIT and by year, but many pay quarterly. This can be attractive if you want steady cash flow from your investment.

The catch is tax treatment. Dividends from REITs are taxed as ordinary income at your regular tax rate, not at the lower capital gains rate that applies to stock dividends. If you are in a high tax bracket, this matters significantly. A REIT dividend of $1,000 might cost you $370 in federal taxes if you are in the 37 percent bracket, whereas a stock dividend of $1,000 might cost you $200 at the 20 percent capital gains rate. Holding REITs in a tax-deferred account like an IRA or 401(k) reduces this problem because the dividends grow without immediate tax.

REIT share prices and interest rate risk

Even though REITs own physical buildings, their share prices move like stocks. When the stock market drops, REIT shares often drop too. When interest rates rise, REIT shares typically fall because investors can get better returns from bonds, and because higher rates make it more expensive for REITs to borrow money to buy or improve properties.

This volatility cuts both ways. If you buy REIT shares when prices are low and sell when they recover, you can make money on the price increase. But if you need to sell during a downturn, you may lock in a loss. Someone who bought REITs in late 2021 and sold in early 2023 would have lost money, even though the underlying real estate was still generating rent.

Advantages of owning REITs

REITs let you own real estate without the work of being a landlord. You do not manage tenants, handle repairs, deal with vacancies, or maintain properties. The REIT company does that. This appeals to investors who want real estate exposure but do not want to be in the property business.

REITs also offer diversification. A single REIT might own dozens or hundreds of properties across different locations and property types. Buying one REIT share gives you a piece of that spread. Buying individual rental properties requires much more capital and leaves you concentrated in one building or neighborhood.

The entry cost is low. You can buy REIT shares for the price of a single share — often $20 to $100 — through any brokerage account. Buying an actual apartment building or office complex requires hundreds of thousands of dollars and a mortgage application.

Disadvantages of owning REITs

You have no control. When you own a rental property, you decide when to sell, what to charge for rent, and how much to spend on improvements. With a REIT, the company's management makes those decisions. If you disagree with their strategy, you can sell your shares, but you cannot change how they run things.

REITs are sensitive to interest rate changes in ways that physical property ownership is not. If you own a rental house with a fixed-rate mortgage, rising interest rates do not affect your monthly payment. But REIT share prices often fall when rates rise, and the company's cost of borrowing increases, which can reduce future dividends.

Fees matter. Many REITs charge management fees that reduce your returns. Some REITs sold through financial advisors come with sales commissions. These costs are not always obvious in the share price, but they reduce what you actually earn.

Types of REITs and what they own

REITs focus on different kinds of real estate. Residential REITs own apartment buildings and single-family rental homes. Commercial REITs own office buildings and retail space. Industrial REITs own warehouses and distribution centers. Healthcare REITs own hospitals, medical offices, and senior living facilities. Specialty REITs own data centers, cell towers, or self-storage units.

The type of property matters because different sectors perform differently depending on economic conditions. During a recession, office and retail REITs often struggle because businesses cut space or close. Residential and healthcare REITs tend to hold up better. If you believe one sector will outperform, you can choose a REIT focused on that sector. If you want broad exposure, you can buy a REIT index fund that holds many different types.

REITs versus owning rental property directly

Owning a rental house gives you control, a fixed mortgage payment, and the ability to use leverage — borrowing money to buy more property than you could with cash alone. You also get tax deductions for mortgage interest, property taxes, repairs, and depreciation. These deductions can reduce your taxable income significantly.

But rental property requires capital upfront, a mortgage application, property management time or money, and concentration risk — your money is tied up in one location. If the neighborhood declines or a major repair is needed, you bear the full cost. REITs spread that risk across many properties and locations.

For most people, the choice is not REIT or rental property — it is REIT or no real estate investment at all. If you have $5,000 to invest, you cannot buy a rental house, but you can buy REIT shares. If you have $200,000 and are comfortable being a landlord, rental property might make sense. If you have $200,000 and want real estate exposure without the work, REITs are an option.

How to evaluate a specific REIT

Before buying shares, look at the REIT's dividend yield — the annual dividend divided by the share price. A yield of 3 to 5 percent is common, but higher yields can signal that the market thinks the dividend is at risk. Check whether the dividend has been stable or growing over the past few years.

Look at the REIT's debt level. REITs use borrowed money to buy properties, which is normal, but too much debt makes them vulnerable if interest rates rise or if property values fall. Compare the REIT's debt to its total assets and to other REITs in the same sector.

Read the annual report or fact sheet to understand what properties the REIT owns, where they are located, and what percentage are occupied. High vacancy rates mean less rent coming in and lower future dividends. Check whether the REIT is buying new properties or selling old ones, and whether management is making decisions that align with your outlook.

Frequently Asked Questions

Can I lose money on a REIT?

Yes. REIT share prices can fall if the stock market declines, if interest rates rise, or if the properties the REIT owns lose value or become harder to rent. You can also lose money if the REIT cuts its dividend because the properties are not generating enough income. The underlying real estate may still be valuable, but your shares could be worth less than you paid.

Are REITs safer than stocks?

Not necessarily. REITs are stocks — they trade on exchanges and move with market conditions. They are backed by physical real estate, which some people find reassuring, but that does not make them safer. During the 2008 financial crisis, REIT prices fell sharply even though the buildings still existed. Real estate is more stable than stocks over very long periods, but REIT share prices are not.

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

A retirement account like an IRA or 401(k) is usually better because REIT dividends are taxed as ordinary income. In a retirement account, the dividends grow without immediate tax. In a regular account, you pay tax on each dividend every year, which reduces your returns. Check whether your retirement account provider offers REIT options or REIT index funds.

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

A REIT is a company that owns real estate and must distribute 90 percent of income. A real estate mutual fund is a pool of money that buys REIT shares or real estate company stocks. The mutual fund does not have to distribute income, so it may be more tax-efficient. Both give you real estate exposure without buying property yourself, but they work differently.

Do I need to pick individual REITs or can I buy a fund?

You can do either. Picking individual REITs requires research into each company's properties, debt, and management. Buying a REIT index fund or exchange-traded fund (ETF) spreads your money across many REITs automatically, which reduces the risk that one bad REIT hurts your returns. For most investors, a fund is simpler and safer.