Why It Matters
REITs exist to pass real estate income directly to investors without the tax drag of a traditional corporation. That 90% distribution requirement is what makes REIT dividends distinctively high compared to most equities — but it also means REITs retain little cash for reinvestment, relying on debt and equity markets to fund growth. When Raj compares a REIT to a rental property he owns outright, the dividend is the equivalent of collecting rent after the mortgage, taxes, and operating expenses are paid — except the REIT handles all of that and deposits a check in his brokerage account every quarter.
At a Glance
- Legal minimum: REITs must distribute at least 90% of taxable income annually
- Payment frequency: Quarterly is most common; some REITs pay monthly
- Typical yield range: 3%–8% for equity REITs; higher for mortgage REITs
- Tax treatment: Most REIT dividends taxed as ordinary income, not qualified dividends
- Key metric: FFO (Funds From Operations) — not net income — drives sustainable payout levels
How It Works
The 90% rule and why it exists. Congress created the REIT structure in 1960 to let ordinary investors access large-scale commercial real estate. The trade-off: REITs avoid corporate income tax only if they distribute at least 90% of taxable income to shareholders. That mandatory payout produces the consistently high yields that make REITs attractive as income investments. Missing the threshold for even one year can strip a REIT of its special tax status, so management treats the distribution as near-inviolable.
FFO drives the real payout math. Standard net income understates REIT earnings because it deducts depreciation — a non-cash charge that can be enormous for a portfolio of buildings. FFO adds depreciation back and strips out property sale gains, giving a cleaner picture of recurring cash generation. Analysts refine that further with AFFO, which subtracts maintenance capital expenditures and straight-line rent adjustments. AFFO is what actually funds the dividend over time; a payout ratio above 100% of AFFO is a warning sign.
NAV and dividend sustainability. NAV (Net Asset Value) tells you what the underlying properties are worth per share. A REIT trading at a deep discount to NAV may look attractive on yield, but if asset values are declining, future dividend cuts become likely. Conversely, a premium to NAV prices in growth expectations the current dividend alone doesn't justify. Comparing dividend yield to NAV is how institutional analysts decide whether a payout is durable.
Tax treatment matters more than it looks. Unlike qualified dividends from most stocks — taxed at the preferential 15%–20% capital gains rate — REIT dividends are classified as ordinary income taxed at your marginal rate (up to 37%). The 20% pass-through deduction under Section 199A partially offsets this. Holding REITs in a tax-deferred account like an IRA eliminates the ordinary-income disadvantage entirely.
Real-World Example
Raj holds 500 shares of a diversified equity REIT at $42 per share — a $21,000 position. The REIT pays a quarterly dividend of $0.38 per share, putting $190 into his account every quarter, or $760 annually — a yield of about 3.6%.
Before buying, Raj checked that the REIT's AFFO was $1.72 per share annually. With the $1.52 annual dividend, the AFFO payout ratio is 88% — sustainable headroom. He also looked at NAV: analysts estimated $44 per share, so the REIT traded at a 4.5% discount, not a red-flag premium. He compared this against a real estate note offering 7% interest — passive income with no equity upside — and decided the REIT's combination of dividend plus potential NAV appreciation made more sense for his long-term allocation. He holds it in his Roth IRA, converting the ordinary-income tax treatment into tax-free growth.
Pros & Cons
- Mandatory 90% payout rule produces income yields that most equities cannot match
- No landlord work — dividends arrive without tenants, maintenance calls, or vacancies to manage
- Liquidity advantage over direct property: shares sell in seconds versus months for a closing
- Diversification across hundreds of properties and markets from a single ticker
- REIT dividends held inside an IRA grow tax-deferred or tax-free, neutralizing the ordinary-income disadvantage
- Most REIT dividends taxed at ordinary income rates — not the preferential 15%–20% qualified dividend rate
- Dividend cuts happen when property income falls, occupancy drops, or interest costs spike
- REIT shares fall in rising-rate environments as bond yields compete directly with dividend yields
- REITs retain little cash, making them dependent on debt and equity markets to fund acquisitions
- High-yield REITs sometimes signal distress — a 12% yield can mean the market expects a cut
Watch Out
Yield alone is a trap. A REIT advertising a 10% yield may be returning your own capital, not earning it from operations. Check the AFFO payout ratio: if dividends exceed AFFO, the payout is mathematically unsustainable. Mortgage REITs amplify this risk — they borrow short and lend long, so an inverted yield curve can compress spreads and force dividend cuts with very little warning.
Qualified Opportunity Zone overlap. If you are comparing REIT income to a qualified opportunity zone investment, remember that QOZ gains are deferred and can be excluded from tax entirely after a 10-year hold. REIT dividends produce current-year taxable income with no deferral. For a taxable account, the after-tax math often favors QOZ for large, long-term capital — but REITs win on liquidity and annual cash flow.
Know what type of REIT you own. Equity REITs earn rent from properties; mortgage REITs earn interest from loans secured by real estate. Mortgage REIT dividends can be higher but are far more volatile — their income depends on interest rate spreads rather than lease agreements. The dividend mechanics look the same; the risk profile is entirely different.
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The Takeaway
A REIT dividend is one of the most accessible forms of real estate income — no debt, no maintenance, no tenant calls, just a quarterly deposit. The 90% distribution rule that creates high yields also limits growth reinvestment, so REIT dividends are best understood as income vehicles, not wealth compounders on their own. Evaluate payout sustainability through AFFO, anchor valuations to NAV, hold in tax-advantaged accounts when possible, and treat any yield above 8%–9% as a signal to dig deeper before buying.