Investing in REITs

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Congress created the REIT structure in 1960 to allow individual investors to participate in large-scale commercial real estate — previously accessible only to institutions and wealthy investors.

To qualify as a REIT under IRS rules, a company must meet strict requirements that distinguish REITs from ordinary real estate companies.

REIT Qualification Rule	Requirement
Income test	At least 75% of gross income from real estate rents, mortgage interest, or property sales
Asset test	At least 75% of total assets in real estate, cash, or government securities
Distribution requirement	Must pay at least 90% of taxable income as dividends to shareholders annually
Shareholder test	At least 100 shareholders; no 5 individuals may own more than 50% ("5/50 rule")
Corporate structure	Must be organized as a corporation or trust and be taxable as a domestic corporation

Because REITs distribute most of their income and cannot retain large amounts of cash, they frequently raise capital through stock and bond offerings — which is why evaluating REIT balance sheet leverage is important when picking individual REITs.

Tip: REITs avoid corporate income tax at the entity level when they meet distribution requirements — they effectively pass real estate income directly to shareholders, who then pay tax at the individual level. This single layer of taxation is a structural advantage over traditional C-corporations that own real estate.

REITs span a wide range of property types, each with different economic drivers, lease structures, and risk profiles. Specialization has deepened significantly — today's REIT market includes everything from cell towers to senior housing to data centers.

REIT Type	What It Owns	Largest Examples	Key Risk
Retail	Shopping malls, strip centers, net-lease stores	Realty Income (O), Simon Property Group (SPG)	E-commerce disruption
Residential	Apartment complexes, single-family rentals, student housing	AvalonBay (AVB), Invitation Homes (INVH)	Rent regulation, overbuilding
Industrial	Warehouses, logistics centers, distribution hubs	Prologis (PLD), EastGroup (EGP)	Tenant concentration
Healthcare	Medical office, hospitals, senior housing, skilled nursing	Welltower (WELL), Ventas (VTR)	Reimbursement policy changes
Data center	Server farms, colocation facilities	Equinix (EQIX), Digital Realty (DLR)	Technology obsolescence
Self-storage	Storage unit facilities	Public Storage (PSA), Extra Space (EXR)	Local supply additions
Mortgage REITs (mREITs)	Mortgages and MBS, not physical property	Annaly Capital (NLY), AGNC Investment	Interest rate risk; leverage

Warning: Mortgage REITs (mREITs) are fundamentally different from equity REITs — they lend money secured by real estate rather than owning properties. They carry significantly higher interest rate sensitivity and leverage risk, and their high headline yields often reflect return of capital rather than sustainable income.

REITs are among the highest-yielding equity investments. The Vanguard Real Estate ETF (VNQ) has historically yielded 3–5% annually, compared to 1.3–1.5% for the S&P 500. Combined with long-run price appreciation, total returns have been competitive with the broad stock market — REITs returned approximately 9.5% annually from 1994 to 2024.

However, REIT dividends receive less favorable tax treatment than qualified dividends from ordinary stocks. Understanding how REIT income is categorized matters significantly for after-tax returns.

Dividend Type	Tax Rate (for a 24% bracket taxpayer)	How It Arises
Ordinary REIT dividend	24% (ordinary income rate)	Most REIT distributions — rental income passed through
Qualified REIT dividend	~18.8% (20% × 0.8 via Section 199A deduction)	20% pass-through deduction reduces taxable income by 20%
Return of capital	0% now; reduces cost basis (deferred until sale)	Distributions exceeding REIT's earnings and profits
Capital gain distribution	15–20% (long-term capital gain rate)	Gains from REIT property sales passed through

The Section 199A deduction (established by the 2017 Tax Cuts and Jobs Act, currently scheduled through 2025 and potentially extended) allows individual investors to deduct 20% of qualified REIT dividends from taxable income, partially offsetting the ordinary-income disadvantage.

Tip: Hold REITs in a tax-advantaged account (IRA, 401(k)) rather than a taxable brokerage account to defer or eliminate the ordinary income tax on REIT dividends. In a Roth IRA, REIT income compounds completely tax-free.

Not all REITs trade on stock exchanges. Non-traded REITs and private REITs are sold directly to investors through broker-dealers and financial advisors, often with high commissions and limited liquidity. Understanding these differences is critical before investing.

Feature	Publicly Traded REIT	Non-Traded REIT	Private REIT
Stock exchange listed	Yes (NYSE, Nasdaq)	No	No
Liquidity	Daily, like any stock	Quarterly / limited redemption	Very illiquid; years lockup
Price transparency	Real-time market price	Appraised NAV (updated quarterly)	Infrequent / opaque
Typical upfront commission	0% (brokerage trading cost)	5–7% sales load	1–3%
Annual management fee	0.03–0.12% (via ETF)	1.25–2.0%	1.0–2.0%
Redemption gates	None	Can suspend redemptions in stress	Common
Examples	PLD, O, WELL, VNQ ETF	Blackstone BREIT, Starwood SREIT	Institutional funds

Blackstone's BREIT suspended redemptions in late 2022 after redemption requests exceeded the monthly 2% / quarterly 5% cap, illustrating that non-traded REIT liquidity guarantees can fail precisely when investors most want out.

Warning: Non-traded REITs have historically underperformed publicly traded REITs net of their high fees and commissions. A 2012 SEC study found that on average, non-traded REITs returned investors substantially less than their original per-share offering price after accounting for distributions and final liquidation value.

Most investors are best served by holding REITs through a low-cost ETF rather than selecting individual REIT stocks. Individual REITs carry concentration risk tied to specific property types, geographies, and management teams; ETFs spread this across 100–200+ REITs automatically.

Vehicle	Ticker	Expense Ratio	Holdings	12-Month Yield (approx)
Vanguard Real Estate ETF	VNQ	0.12%	~160 REITs	~3.5–4.0%
Schwab US REIT ETF	SCHH	0.07%	~140 REITs	~3.3–3.8%
iShares Core US REIT ETF	USRT	0.08%	~175 REITs	~3.5–4.0%
Vanguard Global ex-US Real Estate	VNQI	0.12%	~700 international REITs	~3.0–4.0%

• A reasonable allocation for most investors is 5–10% of the equity portion of the portfolio in REITs — enough to add diversification without overconcentrating in a single sector.
• If your total-market index fund already holds REITs (VTI includes REITs at their market-cap weight of ~3–4%), you have some REIT exposure without doing anything extra.
• For higher REIT exposure than market weight, add a REIT ETF on top; this tilts the overall real estate weight without eliminating other holdings.

Tip: Realty Income (O) is a popular individual REIT often called the "monthly dividend company" — it pays dividends monthly rather than quarterly and has increased its dividend for 27+ consecutive years. While it is not a substitute for diversification, it illustrates the income-generating consistency that quality equity REITs can offer.