What Are REITs? A Guide To Real Estate Investment Trusts

Investing in real estate can be an attractive way to put your money to work for you — but what if you don’t have enough money to buy property outright? One way to start investing in real estate without the need for a large chunk of capital is to buy shares of a real estate investment trust, or REIT. 

REITs are companies that own, finance or manage properties that are required by law to pay most of their generated income to investors. This income can come from the rents that the properties’ tenants pay or even from mortgage payments on loans owned by the REIT. REITs pay out substantial dividends, which can make them a great pick for income investors, although they come with some disadvantages, too.

How REITs work

In order to be considered a REIT, a company must meet certain criteria:

• At least 75 percent of the company’s assets must be invested in real estate.
• At least 75 percent of the company’s gross income must come from interest on mortgages, sales of real estate or rents received from properties.
• The company must be taxed as a corporation and managed by trustees or a board of directors.
• There must be at least 100 shareholders, and no more than 50 percent of its shares can be held by five or fewer people.
• At least 90 percent of a REIT’s taxable income each year must be paid out to shareholders as dividends.

If it opts to be treated as a REIT, it may legally avoid corporate taxation and generate hefty dividend payouts to investors.

In exchange for paying out most of its taxable income, the REIT is able to avoid taxation on its earnings at the corporate level. This legal structure makes it easier and cheaper for REITs to acquire real estate, meaning they can acquire property more easily than non-REITs can.

In essence, a REIT profits from its real estate holdings, and shareholders have a chance to profit as well. You can enjoy capital appreciation when the REIT’s share price increases, as well as benefit from regular dividend payouts.

Many REITs specialize in a specific type of property, such as apartments or data centers, but others have more diverse portfolios. With a REIT, you have access to one of the best investment opportunities without the need for a substantial amount of cash to purchase property or buy into a real estate investment club.

Shares of publicly traded REITs can be bought and sold on major exchanges using any of the best brokers for stock trading.

Types of REITs

There are three main types of REITs:

REITs can also be classified by whether they’re publicly traded, non-traded or private:

• With a publicly traded REIT, any investor can purchase the REIT’s stock on an exchange.
• Non-traded REITs, also called public non-listed REITs, don’t trade on exchanges, even though they’re registered with the Securities and Exchange Commission (SEC).
• Private REITs aren’t registered with the SEC and can be bought without going through an exchange. However, these might be less liquid and transparent than public REITs, so they come with serious risks.

Along with their classification, a REIT can fall into the following property sub-sectors:

• Data centers
• Diversified (or a combination of properties)
• Healthcare
• Industrial (for example, warehouses)
• Infrastructure (such as energy pipelines)
• Lodging
• Mortgage (mREIT)
• Office
• Residential
• Retail
• Self-storage
• Specialty (for example, casinos)
• Timberland

And new sub-sectors may develop as the industry evolves.

Advantages and disadvantages of REITs

REITs can be an attractive investment, but like all investments, they can also come with their own risks and disadvantages. Here are some key advantages and disadvantages of REITs:

Advantages of REITs

• High dividend yields: REITs typically offer some of the highest yields in the stock market, because they’re obligated to make payouts and they have consistent cash flow from their rentals.
• Diversification: By owning a REIT, you may own dozens, even hundreds, of properties across the U.S., meaning that your own risk is reduced by diversification, unlike if you owned one or two properties in a single geographic area.
• Lower correlation with other assets: With less correlation to other assets, REITs can decrease your portfolio’s volatility. When stocks zig, REITs may zag, or at least zig a little less than stocks.
• No self-management: If you’re managing your own property, you may be called on at any point to fix something, which may require you to get out and do it or otherwise pay someone else to do it. You may also be on the hook for serious money if something breaks. So REITs can be a great alternative to investing directly in real estate.
• No commissions (on publicly traded REITs): Unlike real estate and private and non-traded REITs, you can move in and out of public REITs with effectively no commissions. That’s a huge contrast with traditional real estate, where you can expect to pay 6 percent every time you sell, though pricing may be shifting somewhat due to legal changes.

Disadvantages of REITs

• High debt loads: It’s normal for REITs to operate with high debt loads, just like regular homeowners do. But investors need to check to make sure the REIT can sustain the debt load and keep on paying its dividend, or the stock will fall.
• Beholden to market to grow: Because REITs pay out so much of their cash flow, they must raise money from the market to acquire more buildings and grow. When the market is uncooperative — with low stock prices or high interest rates — then it’s hard for REITs to make attractive deals.
• Unsustainable dividends: Investors must remain on the lookout for unsustainable dividends. A dividend cut (or a potential one) will hurt the REIT stock price quickly.
• Rising interest rates: Rising rates may hurt REITs in a few ways, by raising the cost of their financing, reducing the value of their assets (buildings) and depressing their stock price.
• Governance issues: Non-traded REITs and private REITs have potentially serious governance issues and don’t have to follow the higher standards publicly traded REITs must adhere to.
• High commissions and no secondary market: If you’re buying non-traded or private REITs, you should also watch out for massive sales commissions and understand that it will be difficult for you to exit the position, regardless of what the salesperson says.

REITs can be an attractive investment, but you’ll want to steer clear of the biggest mistakes in investing in them.

How to find REITs

If you’re looking to find a list of all REITs, you’ll find them on the website of Nareit, an association that represents REITs. You’ll be able to filter them on basic criteria such as their filing status, returns and sub-sector.

You’ll also be able to find information on any REIT registered with the SEC, including non-traded REITs and publicly traded REITs. Each type of REIT files financial disclosures with the SEC, so investors and others can see how they are performing. You can find the filings in the SEC’s EDGAR database, which goes back more than two decades.

How to invest in REITs

Investing in REITs is fairly straightforward, especially if you focus on publicly traded companies. In that case, all you need to know is the ticker symbol. You can then go to your broker and buy shares, placing an order like you would for any other stock. You can also buy shares in top REIT ETFs, including one of the most popular, the Vanguard Real Estate Index Fund (VNQ). REIT ETFs give you broad exposure to the sector, reducing your risk. 

On top of that, you might be able to allocate a portion of your regular 401(k) contribution to a REIT. Some plans include a REIT fund as an option. However, while individual equities aren’t always included in a 401(k), you can purchase REITs if your administrator does allow them.

Do REITs have a good track record of performance?

REITs have a good track record over time. Equity REITs delivered a 9.7 percent annual return on average from 1998 to 2022, making it the second-best asset class over the period, according to Nareit. By comparison, the S&P 500 stock index historically sees annualized returns of around 10 percent.

It’s important to note, however, that past performance isn’t a guarantee that REITs will perform well in the future. For example, in the five years to June 2024, the FTSE Nareit All Equity REITs index returned just 3.4 percent annually on average.

Should you invest in REITs?

Depending on your risk tolerance and portfolio goals, adding some real estate exposure through REITs could help you further diversify and provide exposure to another asset class that may lower risk in your portfolio. Carefully consider your individual situation and consult with an investment professional to decide whether investing in REITs makes sense for you, and if so, how much you should allocate to them.

— Miranda Marquit wrote a previous version of this story.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.