Real estate has long been one of the most attractive ways to build wealth. But for many people, buying and managing property directly is expensive, time-consuming, and risky. This is where REITs come in. A Real Estate Investment Trust, or REIT, gives everyday investors access to income-producing real estate without having to purchase property themselves.
How REITs Work
A REIT is a company that owns, operates, or finances real estate across a variety of sectors such as apartment buildings, shopping centers, office towers, warehouses, data centers, and even cell towers. Instead of buying an apartment complex or office building on your own, you can buy shares in a REIT and gain exposure to the rental income and potential property appreciation.
By law, REITs must meet specific requirements to qualify for their tax advantages. The most important rule is that a REIT must pay out at least 90% of its taxable income to shareholders in the form of dividends. This makes them a popular choice for income-focused investors.
A worked example: the 90 percent rule in action
The 90 percent rule is the engine behind REIT yields. Say a REIT earns $10 million in taxable income in a year. To keep its REIT status and avoid corporate income tax, it must distribute at least $9 million to shareholders as dividends. With 10 million shares outstanding, that is $0.90 per share in dividends.
At a $12 share price, that $0.90 payout is a 7.5 percent dividend yield, far above the roughly 1.3 percent yield of the broader stock market. The catch is the reason for the high payout: the REIT keeps almost nothing to reinvest, so growth comes mainly from raising rents and acquiring properties, not from compounding retained earnings. You are buying an income stream first and growth second.
Types of REITs
There are several categories of REITs:
- Equity REITs – These own and operate real estate. They generate income primarily through rent from tenants.
- Mortgage REITs (mREITs) – These provide financing for real estate by purchasing or originating mortgages. They earn money from the interest on these loans.
- Hybrid REITs – These combine elements of both equity and mortgage REITs.
Most individual investors put their money into publicly traded equity REITs because they are easy to buy and sell through the stock market, much like shares of any other company.
Benefits of Investing in REITs
There are several reasons investors consider REITs as part of their portfolio:
- Diversification – Real estate often moves differently than stocks or bonds, offering balance to an investment portfolio.
- Dividend Income – Since REITs are required to distribute most of their income, they typically offer higher dividend yields than many other stocks.
- Accessibility – Buying shares in a REIT is far less expensive and more liquid than purchasing physical property.
- Professional Management – REITs are managed by professionals who handle property acquisition, maintenance, and leasing.
Risks of REITs
As with any investment, there are downsides to consider:
- Interest Rate Sensitivity – REITs can be negatively affected by rising interest rates, which make borrowing more expensive and can reduce demand for dividend-paying assets.
- Market Volatility – Publicly traded REITs fluctuate in price like stocks, so their value can change quickly.
- Sector Risks – Different REITs focus on specific areas of real estate. For example, retail REITs may struggle if brick-and-mortar stores close, while office REITs face challenges if remote work trends persist.
How REIT dividends are taxed
Most REIT dividends are taxed as ordinary income, not at the lower qualified dividend rates. That is the price of the high yield: a REIT dividend taxed at your marginal rate. A slice of the payout can still be qualified dividends or capital gain distributions, and your broker sorts this out for you each year on Form 1099-DIV.
There is also a meaningful deduction. Section 199A of the tax code lets investors deduct 20 percent of qualified REIT dividends, and the One Big Beautiful Bill Act signed in July 2025 made that deduction permanent. For an investor in the top bracket, the effective tax rate on ordinary REIT dividends drops from 37 percent to about 29.6 percent. The deduction does not make REIT dividends as tax-friendly as qualified stock dividends, but it closes the gap more than most investors realize.
FFO and AFFO: the numbers REIT investors actually watch
REIT earnings reports can mislead if you read them like a normal company’s. Real estate wears out on paper: accounting rules force a REIT to record depreciation on buildings that may actually be appreciating in value. That makes net income look worse than the cash the properties generate.
So REIT investors use funds from operations, or FFO: net income plus depreciation and amortization, minus gains from property sales. It is the industry’s standard measure of operating performance. AFFO, adjusted funds from operations, goes one step further by subtracting the recurring maintenance the buildings actually need, like roof repairs and tenant improvements. It is the closest thing to the REIT’s true distributable cash.
The practical rule: judge a REIT’s dividend by its payout ratio against AFFO, not against net income. A dividend that is 90 percent of net income can still be perfectly safe if it is 70 percent of AFFO. Price-to-FFO replaces the price-to-earnings ratio in this corner of the real estate market, and passive income investors who learn the two acronyms read REIT reports with far less confusion.
How to Invest in REITs
Investors have several ways to add REIT exposure to their portfolio:
- Purchase shares of publicly traded REITs through a brokerage account.
- Invest in REIT mutual funds or exchange-traded funds (ETFs) for built-in diversification.
- Explore private or non-traded REITs, though these are less liquid and often more complex.
Should You Invest in REITs?
REITs can be a valuable tool for investors who want regular income, portfolio diversification, and exposure to real estate without owning property directly.
REITs fit especially well for people who are building a balanced long-term portfolio alongside index funds like the S&P 500, short-term treasury bills, and a high-yield savings account.
As always, it is worth considering your risk tolerance and speaking with a financial advisor before making investment decisions.
