What Is REIT (Real Estate Investment Trust)?
A REIT pools investor capital to own and manage rental properties — apartments, offices, malls, warehouses, data centers. You buy shares like a stock. REITs must pay out 90% of taxable income as dividends, so you get steady cash flow. Public REITs trade on exchanges and are liquid; private REITs are illiquid and accredited-only. Long-term, equity REITs have outperformed the S&P 500. They've lagged lately as rates rose.
A REIT is a company that owns and operates income-producing real estate. It must distribute at least 90% of taxable income to shareholders as dividends. That lets you invest in property without buying buildings yourself.
At a Glance
- 90% rule: REITs must distribute 90%+ of taxable income — that’s the trade for avoiding corporate income tax
- Three types: Equity (own properties), mortgage (lend to property owners), hybrid (both)
- Public vs private: Public REITs trade like stocks; private REITs are illiquid, accredited-only
- Tax hit: Most dividends taxed as ordinary income (up to 37%), not the lower capital gains rate
- Evaluation: Use FFO and AFFO, not P/E — depreciation skews earnings
How It Works
The structure. A REIT is a corporation or trust that owns and operates income-producing real estate. Instead of buying a building, you buy shares. The REIT collects rent, pays expenses, and passes at least 90% of taxable income to you as dividends. That 90% rule is why REITs exist. Congress created the structure in 1960 to give everyday investors access to commercial real estate. In exchange for paying out almost everything, REITs avoid federal corporate income tax. You're taxed once — at the shareholder level.
Equity vs mortgage vs hybrid. Equity REITs own the actual buildings. They collect rent, manage properties, and sell when it makes sense. Mortgage REITs don’t own property — they lend. They buy or originate mortgages and mortgage-backed securities and earn interest. When rates rise, mortgage REITs often get crushed. Hybrid REITs do both. For most passive investors, equity REITs are the default. Rent checks, not interest-rate bets.
Public vs private. Publicly traded REITs (think Prologis, Simon Property Group, Equity Residential) list on the NYSE or NASDAQ. You can buy one share. Sell in seconds. There are 225+ of them, over $1 trillion in market cap. Private REITs don’t trade. You buy through a sponsor or platform, and your money's locked up — often 7–10 years. Accredited-only. Public non-traded REITs sit in the middle: SEC-registered, but no exchange. You buy through a broker. They charge 10–15% upfront and lock you in. Tread carefully.
Tax treatment. Here’s the catch. Most REIT dividends are taxed as ordinary income — up to 37% federal plus 3.8% Medicare surtax. A 20% deduction through 2025 softens that to about 29.6% effective, but it’s still worse than qualified dividends or long-term capital gains. Some distributions are return of capital (reduce your cost basis) or capital gains (taxed at 20% max). The 1099-DIV breaks it down. High earners feel the pinch.
Valuation. Don’t use P/E. GAAP accounting forces REITs to depreciate buildings over 27.5 years even when they appreciate. That depresses earnings. Use FFO (Funds from Operations) — net income plus depreciation minus gains on sales. AFFO (Adjusted FFO) subtracts CapEx and is closer to true dividend-paying capacity. Compare price-to-FFO or price-to-AFFO across peers. NAV (net asset value per share) tells you if the REIT trades above or below the value of its properties. A REIT trading at 0.8x NAV might be cheap — or the market might be pricing in a worse cap rate than you assume.
Real-World Example
Investor: Marcus, 38, software engineer. Wants real estate exposure without managing properties.
Choice: Buys $50,000 of Equity Residential (EQR) — a publicly traded apartment REIT with 300,000+ units across the Sun Belt and coastal markets.
What he gets: Dividend yield around 4.2%. That’s $2,100/year in cash, paid quarterly. No tenant calls. No roof replacement. No evictions. He can sell his shares any trading day.
Tax hit: He’s in the 32% bracket. Most of that $2,100 is ordinary income. After the 20% deduction, his effective rate on that slice is about 25.6%. He pays $538 in federal tax on the dividend. If it were qualified dividend income, he’d pay 15% — $315. The REIT structure costs him $223/year in extra tax on that $50K position.
Trade-off: He gave up some tax efficiency for liquidity and passivity. He could've put $50K into a syndication and gotten depreciation benefits, but his money would've been locked up 5–7 years. For him, the trade-off works.
Pros & Cons
- Liquidity: Buy and sell like a stock. No 5-year lockups.
- Low barrier: One share of a public REIT can cost $50–$150. No $50K minimums.
- Passive: No property management. Dividends hit your account.
- Diversification: One ticker can own hundreds of properties across dozens of markets.
- Steady income: The 90% rule forces payouts. Dividend yields often 3–6%.
- Tax drag: Dividends taxed as ordinary income, not capital gains. High earners pay more.
- Interest-rate sensitivity: REITs often drop when rates rise — cap rates expand, values compress.
- No control: You don’t pick the assets, the leverage, or the exit. Management does.
- Recent underperformance: Past decade, S&P 500 beat REITs (11.1% vs 7.2% annualized).
- Private REIT pitfalls: Illiquid, high fees, no independent performance data. Easy to get stuck.
Watch Out
Chasing yield. A 10% dividend might mean the REIT's cutting the payout soon or the stock is cratering. Check the payout ratio — dividends as a % of FFO or AFFO. Over 90% is risky. Over 100%? Unsustainable.
Ignoring leverage. REITs use debt. When rates spike, refinancing costs rise and values fall. Compare debt-to-EBITDA or debt-to-assets across peers. The most leveraged REITs get hit hardest in downturns.
Treating private REITs like public ones. Private REITs promise higher yields and "institutional" access. They also lock you up, charge 10–15% upfront, and have no daily pricing. If you need liquidity, stick to public.
Overconcentration in one sector. Retail REITs got crushed by e-commerce. Office REITs got hit by remote work. Diversify across property types — apartments, industrial, healthcare, data centers — or buy a diversified REIT ETF.
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The Takeaway
REITs are the easiest way to add real estate to your portfolio without buying a building. You get dividends, diversification, and liquidity. You pay for it in taxes and give up control. For most investors, publicly traded equity REITs are the sweet spot. Evaluate with FFO and AFFO. Watch the payout ratio. Don't chase yield. Want more tax efficiency and can lock up capital? Syndication might fit better. Want maximum control and willing to manage? Go direct.