What a REIT is and how it works

A Real Estate Investment Trust (REIT) is a company that owns or finances income-producing real estate — apartment buildings, office parks, shopping centers, warehouses, hotels, or medical facilities. Instead of you buying a single property, a REIT pools money from many investors to buy and manage a portfolio of properties. The REIT collects rent from tenants, covers operating costs and debt, and distributes most of what remains to shareholders.

REITs are structured to avoid corporate income tax as long as they meet specific rules set by the Internal Revenue Service. The main rule: they must distribute at least 90 percent of taxable income to shareholders each year. This requirement is why REITs tend to pay higher dividends than most stocks — the law forces them to return cash to investors rather than reinvest it in the company.

You own a REIT the same way you own any stock: you buy shares through a brokerage account, and the share price moves up and down based on what other investors will pay. The difference is that REITs also pay you a dividend — usually quarterly — from the rent and other income the properties generate.

Key Takeaways

  • A REIT owns or finances real estate and distributes at least 90 percent of its taxable income to shareholders as dividends each year.
  • REITs are taxed differently than regular corporations because they pass income through to investors rather than keeping profits in the company.
  • The share price of a REIT can fall even if the properties are performing well, because the stock market price depends on investor demand, not just property value.
  • REIT dividends are taxed as ordinary income, not as capital gains, which means you pay your regular tax rate on the money you receive.
  • REITs must meet strict rules about what types of property they own, how much debt they carry, and how they distribute income to remain tax-may have access to.

The difference between owning a REIT share and owning property directly

When you buy a REIT share, you own a piece of many properties, not a single building. This means your money is spread across different locations, property types, and tenants — so if one tenant leaves or one building has a vacancy problem, it does not wipe out your investment. You also do not have to manage the property, fix the roof, or deal with tenant complaints. The REIT's management team handles all of that.

The trade-off is that you have no control over which properties the REIT buys or sells, how much debt it takes on, or how aggressively it pursues growth. You also cannot deduct depreciation or mortgage interest the way you can with a property you own directly. And unlike a rental property, you cannot borrow against your REIT shares to buy more real estate.

Direct property ownership also gives you leverage: you can put down 20 or 25 percent and borrow the rest, so a small change in property value creates a large percentage gain or loss on your money. REIT shares move with the stock market, so they are more liquid — you can sell them in seconds — but they are also more volatile on any given day.

How REITs generate income and pay dividends

A REIT makes money from rent paid by tenants. After collecting rent, the REIT pays operating expenses: property taxes, insurance, maintenance, utilities, property management salaries, and debt service on any mortgages. What is left over is called net operating income. The REIT then distributes at least 90 percent of its taxable income to shareholders, usually as a quarterly dividend.

The dividend amount varies depending on how much income the properties generated that quarter and how much the REIT spent. A REIT that owns office buildings in a weak market might cut its dividend if vacancy rates rise and rent collection falls. A REIT that owns industrial warehouses during a period of strong e-commerce demand might increase its dividend. The dividend is not may provide — it can go up or down.

Some REITs also make money by selling properties at a profit or by refinancing debt at lower interest rates. These gains are also passed to shareholders, though they may be taxed differently than regular dividend income.

Types of REITs and what they own

REITs are grouped by the type of property they focus on. Residential REITs own apartment buildings and single-family rental homes. Office REITs own commercial office space. Retail REITs own shopping centers and malls. Industrial REITs own warehouses and logistics facilities. Healthcare REITs own hospitals, medical office buildings, and senior living facilities. Specialty REITs own data centers, cell towers, or self-storage units.

Some REITs are diversified, meaning they own multiple property types. Others are focused on a single sector. A diversified REIT may be less volatile because weakness in one property type can be offset by strength in another. A focused REIT may offer higher returns if that sector is booming, but it carries more risk if that sector enters a downturn.

You can also buy a mortgage REIT, which does not own property but instead lends money to real estate developers and owners. Mortgage REITs generate income from interest payments rather than rent, and they tend to behave differently than property-owning REITs, especially when interest rates change.

How REIT share prices move and what affects them

A REIT share price is determined by what investors will pay for it on the stock market, not by the value of the underlying properties. If a REIT owns buildings worth $1 billion and has 100 million shares outstanding, that does not mean each share is worth $10. The share price depends on investor demand, interest rates, economic outlook, and how the REIT's performance compares to other investments.

When interest rates rise, REIT share prices often fall because investors can earn higher returns from bonds and savings accounts, making real estate less attractive. When the economy slows and people worry about job losses, retail and office REITs often fall because tenants may struggle to pay rent. When inflation rises, property values and rents may rise too, which can support REIT prices — but higher inflation also pushes up interest rates, which pushes prices down.

A REIT can own excellent properties with strong tenants and rising rents, but if the overall stock market is selling off or if investors lose confidence in real estate, the share price can still drop. This is why REITs are considered stocks first and real estate second — they move with stock market sentiment as much as with property fundamentals.

Tax treatment of REIT dividends and capital gains

REIT dividends are taxed as ordinary income, not as may have access to dividends. This means you pay your regular income tax rate on the dividend, which is usually higher than the capital gains rate. If you earn $50,000 a year and receive $2,000 in REIT dividends, you pay tax on $52,000 of income at your ordinary rate, not at the lower capital gains rate.

If you sell REIT shares for more than you paid for them, that gain is taxed as a capital gain — short-term if you held the shares less than a year, long-term if you held them longer. Long-term capital gains are taxed at a lower rate than ordinary income for most people.

Some REIT dividends may be labeled as return of capital, which means you are getting back some of your original investment rather than income from operations. Return of capital is not taxed in the year you receive it, but it reduces your cost basis in the shares, so you pay tax on it later when you sell. Your REIT will send you a Form 1099-DIV each January showing how much of your dividend was ordinary income, capital gain, and return of capital.

Risks and downsides of investing in REITs

REITs are sensitive to interest rate changes. When the Federal Reserve raises rates, borrowing becomes more expensive for REITs, and investors shift money to bonds. Both effects push REIT prices down. When rates fall, the opposite happens. This makes REITs more volatile than some other investments.

REITs are also sensitive to economic cycles. During a recession, tenants may default on rent, vacancy rates may rise, and property values may fall. A REIT that owns office buildings faces particular risk if remote work reduces demand for office space. A retail REIT faces risk from e-commerce competition and store closures. You have no control over these sector-specific risks once you own the shares.

Dividend cuts are common during downturns. A REIT that paid a 5 percent dividend one year may cut it to 2 percent the next year if property performance weakens. This can cause the share price to fall sharply because many investors buy REITs specifically for the dividend.

REITs also carry leverage risk. Most REITs borrow money to buy properties, which amplifies gains when property values rise but amplifies losses when they fall. If a REIT takes on too much debt and property values drop, the REIT may struggle to refinance or may be forced to sell properties at a loss.

How to research and compare REITs

Start by identifying the property type that interests you: residential, office, retail, industrial, healthcare, or specialty. Then look at the REIT's funds from operations (FFO), which is a measure of how much cash the REIT generates from its properties. FFO is more useful than earnings for REITs because it excludes depreciation, which is an accounting charge that does not reflect actual cash flow.

Compare the REIT's dividend yield — the annual dividend divided by the share price — to other REITs in the same sector and to other investments. A yield that is much higher than competitors may signal that the market is worried about a dividend cut. A yield that is much lower may mean the market expects strong growth.

Look at the REIT's debt-to-assets ratio to understand how much it is borrowing. Higher leverage can boost returns in good times but increases risk in downturns. Check the occupancy rate — the percentage of rentable space that is leased — to see if the REIT's properties are in demand. Read the quarterly earnings report to understand what is driving performance and what management expects ahead.

Frequently Asked Questions

Can I lose money investing in a REIT?

Yes. REIT share prices can fall if interest rates rise, if the economy weakens, or if the properties underperform. You can also lose money if you buy at a high price and sell at a lower price. The dividend can be cut or eliminated. However, if you hold the REIT long-term and the properties perform well, you can earn returns from both dividend income and share price appreciation.

Do I need a lot of money to invest in a REIT?

No. You can buy a single share of most REITs through a brokerage account, which may cost anywhere from $20 to $200 depending on the REIT. You can also buy a REIT mutual fund or exchange-traded fund (ETF) that holds many REITs, which spreads your money across multiple companies and property types.

What is the difference between a public REIT and a private REIT?

A public REIT trades on a stock exchange and you can buy or sell shares anytime during market hours. A private REIT is not traded publicly and is usually sold through financial advisors. Private REITs are less liquid — you may not be able to sell your shares quickly — and they often have higher fees and longer lock-up periods. Public REITs are generally more transparent and easier to research.

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

Because REIT dividends are taxed as ordinary income, many investors prefer to hold REITs in tax-advantaged accounts like IRAs or 401(k)s, where the dividends are not taxed annually. In a taxable account, you pay tax on the dividend every year, which reduces your after-tax return. However, if your retirement account is small, you may want to hold REITs in a taxable account and use your retirement account for other investments.

Can a REIT go bankrupt?

Yes, though it is uncommon. A REIT can go bankrupt if property values fall sharply, if tenants stop paying rent, or if the REIT takes on too much debt and cannot refinance. During the 2008 financial crisis, some REITs failed or were forced to cut dividends drastically. However, REITs that own essential property types — like industrial warehouses or healthcare facilities — tend to be more resilient than those focused on discretionary sectors like retail or hospitality.