What a REIT is and how it works

A Real Estate Investment Trust (REIT) is a company that owns income-producing real estate — apartment buildings, shopping centers, office parks, warehouses, hotels, or medical facilities — and pays out most of its profits to shareholders. You buy shares in the REIT the same way you buy stock in any other company, through a brokerage account. The REIT uses the money from share sales and borrowed capital to purchase and manage properties. When those properties generate rent or other income, the REIT distributes at least 90 percent of its taxable income to shareholders as dividends.

The mechanics are straightforward: a REIT owns real estate, collects rent or lease payments from tenants, covers operating costs and debt service, and passes the remainder to you. You own a fractional stake in that income stream. You do not own the property itself or have any say in how it is managed — that is the REIT's job. Your return comes from two sources: the dividend payments you receive each quarter or month, and any increase in the share price if the REIT's properties become more valuable or the market's appetite for REIT shares grows.

Key Takeaways

  • REITs own and operate income-producing real estate and must distribute at least 90 percent of taxable income to shareholders as dividends.
  • You buy REIT shares through a brokerage account just like stock, and your return comes from quarterly or monthly dividend payments plus potential share price appreciation.
  • REITs are required to have a professional management team and cannot be closely held by a small group of owners, which distinguishes them from private real estate partnerships.
  • REIT dividends are taxed as ordinary income, not capital gains, so the tax treatment is different from stock dividends and depends on your income level.
  • Different REIT types focus on different property sectors — residential, commercial, industrial, healthcare — so your income and risk profile vary based on which REIT you choose.

The legal structure that makes REITs different from other investments

The REIT structure exists because of federal tax law. In exchange for meeting strict requirements, a REIT avoids paying corporate income tax on the money it distributes to shareholders. Instead, shareholders pay tax on the dividends they receive. This pass-through structure is why REITs can afford to pay out so much of their income — they are not paying a corporate tax bill first.

To may have access to as a REIT, a company must meet several conditions set by the IRS. It must own at least 75 percent of its assets in real estate, cash, or government securities. At least 75 percent of its income must come from rents, interest on mortgages, or property sales. It must have at least 100 shareholders and cannot be closely held by five or fewer people. It must have a board of directors and professional management in place. These rules exist to prevent a REIT from being a tax shelter for a handful of wealthy investors.

Because of these requirements, REITs are typically large, publicly traded companies or large private funds. You cannot create a REIT with your friends to buy a single apartment building. The structure is designed for institutional-scale real estate operations.

How REIT income flows to you as a shareholder

When you own REIT shares, you receive distributions — the REIT's term for dividends. Most REITs pay distributions quarterly, though some pay monthly. The amount per share depends on how much income the REIT collected from its properties minus operating expenses, debt payments, and capital improvements. A REIT that owns high-occupancy apartment buildings in strong markets typically generates more income per share than one that owns struggling retail properties.

The distribution is not may provide. If a REIT's properties fall vacant, tenants stop paying rent, or the real estate market weakens, the REIT's income drops and distributions may be cut. Conversely, if the REIT acquires new properties or raises rents, distributions may increase. You receive the distribution in cash, which you can reinvest, spend, or hold. Some brokerages offer automatic reinvestment plans that buy new shares with your distributions.

Your total return also includes or excludes share price movement. If the REIT's properties appreciate in value or investor demand for REIT shares rises, the share price climbs and you gain if you sell. If the real estate market softens or interest rates rise (making bonds more attractive), the share price may fall. This capital gain or loss is separate from your dividend income.

Different REIT types and what they own

REITs specialize by property type. Residential REITs own apartment complexes and single-family rental homes. Commercial REITs own office buildings, shopping centers, and mixed-use developments. Industrial REITs own warehouses and distribution centers. Healthcare REITs own hospitals, medical office buildings, and senior living facilities. Specialty REITs own data centers, cell towers, self-storage facilities, or other niche properties.

Each sector has different income stability and growth prospects. Residential REITs benefit from steady demand for housing but face rent control regulations in some areas. Industrial REITs have thrived as e-commerce drives warehouse demand. Healthcare REITs depend on aging populations and medical spending. Office REITs have faced headwinds as remote work reduced demand for commercial space. Your choice of REIT type affects both your income stream and your exposure to economic cycles.

You can also choose between publicly traded REITs, which trade on stock exchanges and are straightforward to buy and sell, and non-traded REITs, which are sold through brokers but have no public market. Non-traded REITs typically have higher fees and longer holding periods but may offer different return profiles.

How REIT dividends are taxed

REIT dividends are taxed as ordinary income, not as capital gains. This is a critical difference from stock dividends, which often may have access to for lower capital gains tax rates. If you receive $1,000 in REIT dividends, that $1,000 is taxed at your marginal income tax rate — the same rate as wages or interest income. For high-income earners, this can mean a 37 percent federal tax rate plus state and local taxes, depending on where you live.

The tax treatment depends on the type of income the REIT generates. Most REIT dividends are ordinary income. However, some REITs pay a portion of their distributions as capital gains (if the REIT sold properties at a profit) or as return of capital (a return of your original investment, not taxable in the year received but reducing your cost basis). Your REIT will send you a Form 1099-DIV each January showing how much of your distribution is ordinary income, capital gains, and return of capital. You report this on your tax return.

Because of the ordinary income tax treatment, REITs are often held in tax-advantaged retirement accounts like IRAs or 401(k)s, where the dividends are not taxed annually. In a taxable brokerage account, the annual tax bill can be substantial.

Risks and volatility in REIT investing

REITs are not risk-free. Real estate values fluctuate with economic cycles, interest rates, and local market conditions. If a REIT's properties lose value or tenants move out, the REIT's income and share price both decline. Interest rate increases are particularly damaging to REITs because rising rates make bonds more attractive and reduce the present value of future rental income.

Sector-specific risks also matter. Retail REITs suffered when e-commerce reduced foot traffic to shopping centers. Office REITs faced uncertainty as companies adopted hybrid work. Residential REITs in rent-controlled markets have limited pricing power. Healthcare REITs depend on government reimbursement rates. You need to understand what properties your REIT owns and what economic forces affect them.

Leverage is another consideration. Most REITs borrow money to buy properties, which amplifies both gains and losses. A REIT with high debt may offer higher distributions when times are good but faces pressure if interest rates rise or income falls. Check a REIT's debt-to-equity ratio and interest coverage ratio to understand its financial stability.

How to evaluate a REIT before investing

Start by understanding what the REIT owns. Read its annual report or fact sheet to learn which properties it holds, in which geographic markets, and what percentage of income comes from each. A REIT concentrated in one city or property type carries more risk than a geographically diversified one.

Look at the distribution yield — the annual dividend per share divided by the share price. A REIT yielding 5 percent sounds attractive, but compare it to the REIT's historical yield and to other REITs in the same sector. A yield that is much higher than peers may signal financial stress or an unsustainable distribution. Conversely, a very low yield may mean the market expects strong capital appreciation.

Examine the REIT's occupancy rate (the percentage of rentable space that is leased) and rent growth. High occupancy and rising rents suggest strong fundamentals. Falling occupancy or flat rents signal trouble ahead. Check the debt level and whether the REIT can cover its debt payments from operating income. A REIT with rising debt and falling income is at risk of cutting distributions.

Frequently Asked Questions

Can I lose money investing in a REIT?

Yes. The share price can fall if real estate values decline, interest rates rise, or the REIT's properties underperform. Distributions can also be cut if the REIT's income drops. You could sell at a loss or hold through a downturn and recover later, depending on the REIT's fundamentals and the broader market.

Do I have to hold a REIT for a certain amount of time?

No. Publicly traded REITs are liquid — you can sell your shares any trading day. Non-traded REITs often have holding periods of five to ten years and limited liquidity. Check the prospectus before buying a non-traded REIT if you think you might need the money sooner.

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

A REIT is a company that owns and operates real estate directly. A real estate mutual fund is a pool of money that buys shares in multiple REITs or real estate companies. A mutual fund gives you diversification across many REITs and sectors in one purchase, while a single REIT gives you exposure to one company's properties and strategy.

Can I buy REIT shares through my 401(k) or IRA?

Yes, if your plan offers a self-directed brokerage option or a menu that includes REIT mutual funds or ETFs. Many employer 401(k) plans include REIT options. IRAs allow you to buy individual REIT shares or REIT funds. Holding REITs in a retirement account avoids the annual ordinary income tax on distributions.

What happens if a REIT goes bankrupt?

If a REIT becomes insolvent, shareholders typically lose their investment. Creditors and bondholders are paid first from any remaining assets. This is rare for large, established REITs but is a risk with smaller or highly leveraged REITs. Diversifying across multiple REITs or REIT funds reduces this risk.