REITs: Real Estate Through the Stock Market

Many people want real estate in their savings but not a second job as a landlord, a large down payment, or a single building that ties up most of their net worth. A real estate investment trust, or REIT, offers a different route: a share in a large portfolio of properties that you can buy or sell in seconds. This chapter explains what a REIT legally is, the main kinds, how REIT income is taxed and where to hold it, how analysts value REITs, and how much a diversified portfolio usually already owns before you add any.

What a REIT is, and why it pays out so much

A REIT is a company that owns, operates or finances income-producing real estate and has chosen a special tax status. In exchange for paying no corporate income tax on the income it distributes, it must meet tests set by the Internal Revenue Code. The main ones:

• It must distribute at least 90% of its taxable income to shareholders each year as dividends. This is why REIT yields are higher than the stock market's.
• At least 75% of its assets must be real estate, mortgages on real estate, cash or government securities.
• At least 75% of its gross income must come from real estate sources such as rents and mortgage interest.
• It must be widely held: at least 100 shareholders, and no five or fewer individuals owning more than half of it.

The payout rule has a consequence that matters for investors. Because a REIT gives away most of its earnings, it cannot grow much from retained profits. To buy or build new properties it usually issues new shares or borrows. That makes REITs sensitive to interest rates and to the price of their own shares, a point the valuation section returns to.

The main kinds of REIT

Equity REITs own buildings and collect rent. They make up the large majority of the listed REIT market and are what most index funds hold. They specialise by property type, and the types behave very differently:

• Apartments and single-family rentals, where leases reset yearly and demand follows household formation.
• Industrial and logistics warehouses, tied to shipping and online retail.
• Offices, where remote work has cut demand in many cities.
• Retail centres and malls, whose fortunes split between strong and weak locations.
• Healthcare facilities, self-storage, data centres, cell towers and timberland, each with its own drivers.

Mortgage REITs do not own buildings. They lend to property owners or buy mortgage-backed securities, earning the difference between what they borrow at and what they lend at. They often use heavy leverage, pay higher yields, and can lose value quickly when interest rates move against them. They behave more like leveraged bond funds than like property.

Listed versus non-traded REITs. Listed REITs trade on a stock exchange with a daily price. Non-traded REITs are sold directly, often through brokers, may carry high upfront fees, and can be hard or impossible to sell for years. The US Securities and Exchange Commission has published repeated investor warnings about their fees and limited liquidity. The rest of this chapter is about listed REITs.

REITs compared with owning property directly

The volatility row deserves a second look. Listed REITs can fall as much as the stock market in a crisis, while a house's value seems steady because nobody quotes it daily. The underlying risk is closer than it looks; the house simply does not show its price. Chapter 3 covers direct ownership in detail.

How REIT dividends are taxed, and where to hold them

Most REIT dividends are not "qualified dividends". They are taxed as ordinary income at your bracket rate, not at the lower long-term capital gains rates. Part of a distribution may instead be a capital gain distribution or a return of capital, which lowers your cost basis rather than being taxed now; the fund's year-end tax form shows the split.

There is a partial offset. The qualified business income deduction lets individuals deduct 20% of qualified REIT dividends, so only 80% of that ordinary dividend is taxed. The 2025 federal tax law made this deduction permanent; before it, the deduction was set to expire after 2025. For someone in the 22% bracket, the deduction brings the effective federal rate on qualified REIT dividends to about 17.6%, still higher than the 15% most people pay on qualified dividends, and the Net Investment Income Tax of 3.8% applies on top above $200,000 single or $250,000 joint.

A single filer with $95,000 of income in 2026 reaches the 22.0% bracket, so each extra dollar of ordinary REIT dividend is taxed at that rate on the 80% left after the deduction. Because the income arrives every year and is taxed at ordinary rates, a REIT fund held in a taxable account carries noticeable tax drag. Held in a traditional or Roth IRA, the same dividends are not taxed while they stay inside.

Treating the yearly tax on dividends as a drag of 0.8%, a REIT holding of $50,000 growing at 7.0% for 20 years ends near $193,484 with no yearly tax and near $166,518 with it, a difference of about $26,967. The drag in your case depends on the fund's yield and your bracket. This is why REITs sit near the top of the list of holdings to place in retirement accounts, as described in chapter 1. The asset location calculator runs the comparison for your accounts.

How analysts value a REIT

Ordinary earnings per share understate a REIT's cash income, because accounting rules require it to deduct depreciation on buildings that often hold or gain value. REIT analysts use other measures instead.

• Funds from operations (FFO) adds depreciation back to net income and removes gains or losses from selling properties. Price divided by FFO plays the role a price-to-earnings ratio plays for other companies.
• Adjusted funds from operations (AFFO) goes further, subtracting the recurring capital spending needed to keep buildings rentable, such as roofs and new tenant fit-outs. It is closer to the cash actually available for dividends, though companies calculate it in slightly different ways.
• Net asset value (NAV) estimates what the properties would sell for, minus debt. A REIT trading well below NAV may be cheap, or the market may doubt the property values.
• Payout ratio: dividends divided by AFFO. A ratio above 100% for several years means the dividend is being paid from borrowing or new shares, which cannot last.
• Leverage: debt relative to property value or earnings. Heavily indebted REITs suffer most when rates rise or credit tightens.

For most people these measures matter less than they seem, because a broad REIT index fund holds the whole market and avoids the job of picking winners. They are most useful for spotting warning signs in a sector fund or a single company you already own.

How much REIT exposure makes sense

Before adding a REIT fund, check what you already hold. A total US stock market index fund already includes listed REITs at their market weight, typically a few percent of the fund. Many target-date funds also include them. Adding a separate REIT fund is a deliberate overweight to real estate.

People who add a dedicated allocation often keep it between about 5% and 15% of their stock holdings, sized against everything else they own. Factors that argue for a smaller allocation: owning your home (already a large real estate position), owning rental property, or working in real estate or construction, where your income and your investments would fall together. Factors that argue for some: wanting a stream of income tied to rents, which tend to rise with inflation over long periods, and wanting diversification beyond the companies that dominate the stock indexes.

A broad, low-cost index fund covering all property types is the simplest way to hold REITs. Sector funds (only data centres, only healthcare) concentrate the bet and need the valuation work above.