What a REIT does with your money

When you buy shares in a REIT (Real Estate Investment Trust), you own a piece of a company that buys, manages, and sometimes sells real estate. The REIT uses investor money to purchase apartment buildings, office parks, shopping centers, warehouses, hotels, or other properties. It collects rent from tenants, pays the mortgage and upkeep costs, and distributes most of what's left to shareholders like you.

A REIT is not the same as owning rental property yourself. You do not manage tenants, fix the roof, or handle evictions. Instead, a professional management team does that work. You receive regular payments — usually quarterly — based on the REIT's rental income and property sales. The trade-off is that you have no control over which properties the REIT buys or how it operates them.

REITs exist because of a federal rule: if a company owns real estate, collects rent, and distributes at least 90 percent of its taxable income to shareholders each year, it does not pay corporate income tax. That rule makes REITs attractive to investors who want steady income, because the company must pass most earnings through to you rather than keeping them.

Key Takeaways

  • A REIT pools investor money to buy and manage real estate, then distributes most of its rental income to shareholders as regular payments.
  • REITs are required by law to pay out at least 90 percent of taxable income to shareholders, which is why they often offer higher payouts than stocks.
  • You can buy REIT shares through a brokerage account the same way you buy stock, and you can sell them anytime the market is open.
  • REIT dividends are taxed as ordinary income, not at the lower capital gains rate, so holding them in a tax-sheltered retirement account can reduce your tax bill.
  • Different REITs own different property types — apartments, offices, warehouses, malls — so your returns depend on which sector performs well.

How REIT income flows to you

A REIT's income comes from rent paid by tenants. After the REIT pays property taxes, insurance, maintenance, salaries for staff, and mortgage interest, whatever remains is called net operating income. The REIT must distribute at least 90 percent of its taxable income to shareholders. Most REITs distribute more than that — often 95 to 100 percent — because they want to attract investors.

This payout is called a dividend. You receive it in cash, usually four times a year. The amount per share changes based on how much income the REIT earned that quarter. If a REIT owns properties in a strong rental market, dividends may rise. If vacancy rates climb or maintenance costs spike, dividends may fall.

Some REITs also make money by buying properties at a low price, improving them, and selling them at a profit. That capital gain is also passed to shareholders, though it is taxed differently than dividend income. Most REIT income, though, comes from ongoing rent collection, not property sales.

The difference between REIT types

REITs specialize in different kinds of real estate, and each sector behaves differently. An apartment REIT owns residential buildings and profits when rents are high and vacancy is low. An office REIT owns commercial office space; its income depends on how many companies lease space and how long they keep leases. A retail REIT owns shopping centers and malls; it suffers when retail sales decline or stores close.

Industrial REITs own warehouses and distribution centers. They have performed well in recent years because e-commerce companies need space to store and ship goods. Healthcare REITs own medical office buildings, hospitals, and senior living facilities. Hotel REITs own lodging properties and depend on travel and tourism.

Some REITs own a mix of property types, while others focus on one. Your dividend will depend partly on which sector you choose. If you buy an apartment REIT during a time when rents are rising, you may see higher payouts. If you buy a retail REIT when stores are closing, payouts may shrink. Diversifying across different REIT types can reduce this risk.

How to buy and sell REIT shares

You buy REIT shares through a brokerage account — the same account you would use to buy stock in Apple or Microsoft. Open an account with a broker like Fidelity, Charles Schwab, E-Trade, or Vanguard, link a bank account, and transfer money in. Then search for the REIT by its ticker symbol and place a buy order.

REIT shares trade on stock exchanges during market hours, usually 9:30 a.m. to 4 p.m. Eastern time on weekdays. You can sell your shares anytime the market is open. The price you receive depends on what other investors are willing to pay that day — it may be higher or lower than what you paid. This price movement is separate from the dividend you receive.

Many brokers offer dividend reinvestment plans, or DRIPs. Instead of receiving your quarterly dividend in cash, the REIT automatically uses it to buy more shares. Over time, this compounds your investment. You can turn a DRIP on or off whenever you want.

Tax treatment of REIT dividends

REIT dividends are taxed as ordinary income, not as capital gains. This matters because capital gains — profits from selling an investment at a higher price than you paid — are taxed at lower rates. If you hold a REIT in a regular taxable brokerage account, you will owe income tax on every dividend you receive, even if you reinvest it.

For this reason, many investors hold REITs in tax-sheltered accounts like a traditional IRA or 401(k). Inside these accounts, dividends are not taxed each year. You pay tax only when you withdraw money in retirement. This strategy lets your REIT dividends compound without being reduced by annual tax bills.

If you do hold a REIT in a regular brokerage account, the REIT will send you a Form 1099-DIV each January showing how much dividend income you received. You report this on your tax return. Keep records of your purchases and sales so you can calculate capital gains or losses when you eventually sell your shares.

REIT risks and what can go wrong

REIT share prices move up and down like any stock. If interest rates rise, investors may sell REITs to buy bonds instead, pushing REIT prices down. If the economy slows and companies stop leasing office space, office REITs may fall. If a recession hits and people stop traveling, hotel REIT prices may drop sharply.

Dividends are not may provide. A REIT can cut its dividend if rental income falls or if property values decline. This happens most often during recessions or when a specific sector — like retail — faces long-term headwinds. A dividend cut usually causes the share price to fall as well, because investors buy REITs partly for the income.

REITs also carry interest rate risk. Many REITs borrow money to buy properties. When interest rates rise, borrowing becomes more expensive, which can squeeze profits and dividends. Conversely, when rates fall, REITs may refinance debt at lower rates and boost payouts.

REIT funds versus individual REITs

You can buy shares in a single REIT, or you can buy a REIT mutual fund or REIT exchange-traded fund (ETF). A REIT fund holds dozens or hundreds of individual REITs, spreading your money across many properties and sectors. This reduces the risk that one REIT's poor performance will hurt your returns.

A REIT fund charges a fee — usually between 0.1 and 1 percent per year — to cover management costs. That fee is deducted from your returns. Individual REITs do not charge this fee, but you have to research and pick them yourself. Most investors find REIT funds simpler because they offer when ready diversification and require less research.

Both individual REITs and REIT funds pay dividends, and both are taxed as ordinary income. The choice depends on how much time you want to spend researching properties and sectors, and whether you prefer the simplicity of a diversified fund.

Frequently Asked Questions

Do I need a lot of money to start investing in REITs?

No. Most brokers let you buy a single share of a REIT for the price of that share — often between $50 and $200. You can start with a small amount and add more over time. REIT funds may have a minimum investment, but many brokers waive minimums for retirement accounts.

Can I lose money in a REIT?

Yes. REIT share prices fall when interest rates rise, when the economy weakens, or when a specific property sector struggles. You can sell at a loss if you need the money. Dividends can also be cut, which usually causes the share price to drop. However, over long periods, REITs have historically provided steady income and some price appreciation.

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

A REIT is a company that owns and manages real estate directly. A real estate mutual fund is a fund that owns shares in multiple REITs or real estate companies. A REIT fund gives you diversification across many properties and sectors with one purchase, while buying an individual REIT gives you exposure to one company's properties.

How often do REITs pay dividends?

Most REITs pay dividends quarterly — four times per year. Some pay monthly. The exact dates vary by REIT. When you buy a REIT, check its dividend schedule so you know when to expect payments.

Can I hold a REIT in a retirement account?

Yes. You can hold REITs in a traditional IRA, Roth IRA, 401(k), or other retirement account. This is often a good strategy because REIT dividends are taxed as ordinary income, and holding them in a tax-sheltered account lets you avoid annual tax bills on the dividends.