For many people, the idea of real estate investing conjures images of landlords collecting rent checks and dealing with maintenance calls. But there's another way to invest in property—one that requires no tenant screening, no 3 AM plumbing emergencies, and no down payment beyond the cost of a single share. Real Estate Investment Trusts (REITs) let you own a piece of apartment buildings, shopping centers, office towers, and warehouses through the same brokerage account you use for stocks.
REITs were created by Congress in 1960 to give ordinary investors access to income-producing real estate—previously the domain of the wealthy and institutions. Today, REITs own approximately $4 trillion in real estate assets across virtually every property type imaginable, from cell towers to data centers to medical facilities.
What Makes a REIT a REIT?
A REIT is a company that owns, operates, or finances income-producing real estate and meets specific IRS requirements. The most significant requirement for investors: REITs must distribute at least 90% of their taxable income to shareholders as dividends. This creates the high-yield income that makes REITs attractive to income-focused investors. In exchange for this mandatory payout, REITs avoid corporate income tax on the distributed earnings.
The structure creates a unique investment proposition. Because REITs must pay out most of their income, they can't retain as much capital for growth as typical corporations. They often fund expansion by issuing new shares or taking on debt. This means REIT returns come primarily from dividends and property value appreciation, rather than the earnings growth that drives many stocks.
Understanding REIT Categories
Equity REITs are what most people think of when they hear "REIT." These companies own and operate physical properties, collecting rent from tenants. They make money through the spread between rental income and operating costs, plus any appreciation when properties are sold. Approximately 90% of the REIT market consists of equity REITs.
Mortgage REITs (mREITs) take a different approach—they don't own properties at all. Instead, they finance real estate by purchasing mortgage-backed securities or originating loans directly. mREITs profit from the spread between their borrowing costs and the interest they earn on mortgage investments. They tend to offer higher yields than equity REITs but with greater volatility and interest rate sensitivity.
Within equity REITs, specialization is the norm. Some focus exclusively on residential properties—apartment complexes or manufactured housing communities. Others own retail space ranging from regional malls to strip centers to free-standing stores leased to single tenants. Industrial REITs have seen explosive growth by owning the warehouses and distribution centers that power e-commerce. Healthcare REITs own hospitals, medical office buildings, and senior living facilities. Newer sectors include data center REITs, cell tower REITs, and even timberland REITs.
Why Investors Choose REITs
The most obvious advantage is income. REIT dividend yields typically range from 3% to 8%, significantly higher than the S&P 500 average. For retirees or anyone seeking regular cash flow, this steady income stream is compelling. Historically, dividends have contributed roughly two-thirds of total REIT returns over the long term.
Diversification is another key benefit. Real estate often moves independently of stocks and bonds, which can reduce overall portfolio volatility. Adding REITs to a traditional stock-and-bond portfolio has historically improved risk-adjusted returns. You can also diversify within real estate by owning REITs across different property types and geographic regions.
Unlike direct property ownership, REITs offer liquidity. You can buy or sell shares instantly during market hours, just like any stock. There's no property to list, no closing to coordinate, no transaction costs beyond your brokerage commission. This makes it easy to adjust your real estate allocation or access your capital when needed.
Finally, REITs provide access to institutional-quality properties that individual investors could never afford to buy directly. Through a single REIT share, you might own a fraction of Class A office towers in major cities, brand-new distribution centers, or luxury apartment complexes—properties that would require millions in capital to purchase directly.
Understanding the Risks
REITs are sensitive to interest rates. When rates rise, REIT dividend yields become less attractive relative to bonds, often pushing prices down. Rising rates also increase borrowing costs for REITs that use debt to fund acquisitions. However, if rates rise because the economy is strong, increasing rents may offset some of this pressure.
Because REITs trade on exchanges, they experience stock market volatility that doesn't always reflect the value of underlying properties. During market panics, REIT prices can drop sharply even when the properties themselves are performing well. Long-term investors may view this volatility as opportunity, but it can be unsettling for those expecting real estate's perceived stability.
Different property types carry sector-specific risks. Retail REITs face ongoing pressure from e-commerce. Office REITs must adapt to remote work trends. Healthcare REITs depend on government reimbursement policies. Understanding these dynamics is essential before investing in any specific REIT.
Finally, REIT dividends are generally taxed as ordinary income, not at the lower qualified dividend rate. Holding REITs in tax-advantaged accounts like IRAs can help minimize this tax burden.
Getting Started with REIT Investing
The simplest approach is through a REIT ETF or index fund, which holds a diversified basket of REITs. These funds provide instant diversification across property types and individual companies, with minimal research required. Major index funds track the FTSE Nareit All REITs Index or similar benchmarks.
If you prefer to select individual REITs, focus on understanding the specific property types and markets each REIT operates in. Look at key metrics like Funds from Operations (FFO)—the REIT equivalent of earnings per share—dividend coverage, debt levels, and occupancy rates. The company's track record of dividend growth and management quality matter as well.
Non-traded REITs are private offerings not listed on exchanges. They often promise higher yields but come with significant drawbacks: limited liquidity (you may not be able to sell for years), high fees, and less transparency than publicly traded alternatives. Most individual investors are better served by publicly traded REITs.
How much of your portfolio should be in REITs? Many financial advisors suggest a real estate allocation of 5% to 15% for a diversified portfolio, though this varies based on your other assets—if you already own rental property directly, you may want less REIT exposure. What matters most is that your allocation aligns with your income needs, risk tolerance, and overall investment strategy.