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What Are REITs and How Do They Work?

A Real Estate Investment Trust, or REIT, is a company that owns, operates, or finances income-producing real estate. Think of it as a way for regular people to invest in large-scale real estate projects without having to buy property directly. Instead of purchasing a house or apartment building yourself, you can buy shares in a REIT that owns many properties.

REITs must own real estate that generates income. This includes apartment buildings, office spaces, shopping centers, warehouses, hospitals, hotels, and data centers. Some REITs focus on one type of property, while others own a mix. For example, a REIT might own 50 apartment complexes across different cities, generating rental income from thousands of tenants.

The structure of a REIT is fairly straightforward. The company collects rent and other income from the properties it owns. After paying operating costs, maintenance, property taxes, and management fees, the remaining profits go to shareholders in the form of dividends. By law, REITs must distribute at least 90 percent of their taxable income to shareholders each year. This requirement is what makes REITs different from regular real estate companies.

REITs trade on stock exchanges just like regular company stocks. You can buy and sell shares through a brokerage account, making them liquid investments. This means you can convert your investment to cash relatively quickly, unlike owning physical real estate where selling can take months. As of 2024, there are over 200 publicly traded REITs in the United States, managing approximately $4 trillion in real estate assets.

Practical takeaway: Before considering any investment, understand that REITs are stocks representing real estate ownership. They allow diversification across many properties and locations without the time and money required to purchase physical real estate directly.

The Different Types of REITs Available

REITs fall into three main categories based on how they operate and where you can buy them. Understanding these categories helps you learn what options exist in the REIT market.

Equity REITs own and operate real estate properties. They make money from collecting rent and selling properties. When you own shares in an equity REIT, you're essentially a part-owner of the physical buildings and land. For instance, an equity REIT might own 30 shopping malls across the country. The income comes from the retailers who lease space in those malls. Equity REITs are the most common type, representing about 80 percent of the REIT market.

Mortgage REITs lend money to real estate developers and property owners. Instead of owning buildings, they own mortgages and mortgage-backed securities. They earn income from the interest payments borrowers make. Mortgage REITs are more technical and carry different risks than equity REITs. Their income depends on interest rates and borrower performance rather than property management and occupancy rates.

Hybrid REITs combine both approaches. They own some properties directly and also provide financing for other real estate projects. This strategy spreads risk across different income sources, though it adds complexity to understanding their operations.

REITs also divide by how they're traded. Publicly traded REITs are listed on major stock exchanges and can be bought and sold during regular trading hours. Non-traded REITs don't trade on exchanges and are typically sold through broker-dealers or financial advisors. Non-traded REITs are less liquid, meaning you may have difficulty selling your shares quickly. REITs that trade on exchanges offer more transparency because they must file regular financial reports with the Securities and Exchange Commission.

Practical takeaway: Research whether you're looking at an equity REIT (owns properties), a mortgage REIT (lends on real estate), or a hybrid REIT (does both). Check whether the REIT trades publicly on an exchange or is non-traded, as this affects how easily you can buy and sell shares.

Understanding REIT Returns and Dividend Income

One reason people invest in REITs is the income they generate through dividends. By law, REITs must distribute most of their profits to shareholders, which means REIT investors often receive regular dividend payments. This contrasts with many stocks, where companies reinvest profits to grow the business rather than paying dividends to shareholders.

REIT dividends typically yield higher returns than the average stock. As of late 2024, the average REIT dividend yield was around 3 to 4 percent, compared to roughly 1.5 percent for the overall stock market. Some individual REITs offer yields above 5 percent. However, higher yields can sometimes indicate higher risk, so comparing a REIT's yield to others in the same sector provides useful perspective.

Dividends come from several sources. Rental income from tenants is the primary source for most equity REITs. Additional income may come from property appreciation if the REIT sells buildings for more than it paid for them, though selling properties isn't the main business model. For mortgage REITs, all income comes from interest paid on loans they've made.

It's important to understand that dividend yield numbers don't tell the whole story about REIT performance. A REIT share price can go up or down based on market conditions, interest rates, property values, and investor sentiment. You could receive dividends while the share price declines, or see share price increases while dividend payments stay flat. Total return includes both dividend income and changes in share price. From 2015 to 2024, REITs returned an average of about 8.5 percent annually, including both dividends and price appreciation, though returns vary significantly by year and property type.

Practical takeaway: Look at both dividend yield and historical total return when evaluating REITs. Understand that dividend payments and share price movements happen independently, and your overall return depends on both factors.

Key Risks and Considerations for REIT Investors

Like all investments, REITs carry risks that potential investors should understand. Interest rate changes directly affect REIT performance. When the Federal Reserve raises interest rates, borrowing becomes more expensive for REITs, and investors may prefer bonds and savings accounts that offer higher interest income without stock market risk. During these periods, REIT share prices often fall. Conversely, when rates drop, REIT valuations may rise. From 2022 to 2023, when the Fed raised rates significantly, many REITs declined in value despite maintaining their dividend payments.

Economic downturns affect real estate differently depending on property type. During recessions, office occupancy rates may fall as companies downsize or allow remote work. Retail spaces struggle when consumer spending drops. However, apartment and essential services properties tend to hold up better because people still need housing and medical care regardless of economic conditions. Understanding what properties a REIT owns helps you gauge its vulnerability to economic changes.

Sector concentration creates risk. If you own multiple REITs but they all specialize in one property type, you lack true diversification. An investor with five office REITs is heavily exposed to office market problems. Spreading investments across different property sectors—residential, industrial, healthcare, retail—reduces this concentration risk.

Management quality matters significantly. A REIT's board of directors and executive team make decisions about which properties to buy, how to manage them, and what rents to charge. Poor management can destroy value even with good properties. Reading a REIT's annual reports and reviewing management track records provides insight into this risk factor.

Tax implications are another consideration. REIT dividends are typically taxed as ordinary income rather than the more favorable capital gains tax rate that applies to stock dividends. This makes REITs more tax-efficient in retirement accounts like IRAs and 401(k)s where investment income isn't taxed annually.

Practical takeaway: Before investing, understand how interest rates, economic conditions, and property types affect REITs. Diversify across different REIT sectors and property types. Consider holding REITs in tax-advantaged retirement accounts when possible.

How to Research and Compare Different REITs

Researching REITs requires looking at several key metrics and information sources. The SEC's EDGAR database provides free access to all official filings from publicly traded REITs, including annual reports, quarterly earnings reports, and detailed financial statements. These documents contain information about properties owned, financial performance, management discussions, and risk factors.

Key metrics to examine include funds from