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 give everyday investors access to diversified, professionally managed real estate portfolios. Instead of buying and managing buildings directly, investors can purchase shares in a REIT and participate in real estate income and potential appreciation.
To qualify as a REIT under U.S. tax law, a company must meet strict requirements. At least 75% of its assets must be invested in real estate, cash, or U.S. Treasuries. At least 75% of its gross income must come from real estate–related sources such as rents or mortgage interest. Most importantly, a REIT must distribute at least 90% of its taxable income to shareholders annually as dividends.
REITs can hold many types of properties, including office buildings, apartments, shopping centers, hotels, warehouses, data centers, cell towers, healthcare facilities, and timberland. This broad reach allows investors to gain exposure to multiple real estate sectors through a single investment.
Most REITs are publicly traded on major stock exchanges, offering liquidity similar to stocks. There are also public non-listed REITs registered with the SEC but not exchange-traded, and private REITs that are typically available only to institutional or accredited investors. Each structure differs in liquidity, transparency, and investor access.
For many investors, REITs represent a practical entry point into property investment because they remove the operational burdens of direct ownership while still providing exposure to real estate cash flows.
REITs generally follow a straightforward model. Equity REITs acquire or develop properties, lease space to tenants, collect rent, pay operating expenses and financing costs, and then distribute most remaining taxable income to shareholders. These dividends are a primary source of return.
Mortgage REITs, by contrast, do not typically own properties. Instead, they provide financing for real estate by investing in mortgages or mortgage-backed securities. Their income mainly comes from the spread between interest earned on assets and their borrowing costs.
Because REITs must distribute at least 90% of taxable income, they tend to retain less cash than typical corporations. As a result, they often rely on capital markets, issuing debt or equity to fund growth and acquisitions. This makes access to financing and investor confidence especially important.
Investors can access REITs in several ways:
Performance is driven by property fundamentals such as occupancy, rental rates, and property values, as well as broader factors like interest rates and economic conditions. Over long periods, REITs have historically delivered competitive total returns composed of dividend income and capital appreciation.
Scale is another defining feature. U.S. REITs collectively own trillions of dollars in gross real estate assets and hundreds of thousands of properties nationwide. This scale can provide diversification benefits that are difficult for individual owners to achieve.
One of the most distinctive features of REITs is their tax structure. REIT tax advantages stem largely from their pass-through nature. A qualifying REIT generally does not pay federal corporate income tax on earnings it distributes to shareholders. This helps avoid the double taxation that typically applies to C corporations.
For investors, however, REIT dividends are not usually “qualified dividends” taxed at lower capital gains rates. Most REIT dividends are taxed as ordinary income. Still, individual investors may be eligible for the 20% Qualified Business Income deduction on certain REIT dividends, which can lower the effective tax rate. These are often highlighted among key REIT tax benefits.
Distributions can be composed of several elements:
Depreciation plays a major role. Real estate owners, including REITs, claim depreciation deductions that reduce taxable income. When properties are sold, some of those benefits may be subject to Depreciation Recapture rules, potentially taxed at higher rates.
Investors may also encounter Phantom Income in certain structures or years when taxable income allocated exceeds cash received, though this is more common in partnerships than traditional publicly traded REITs.
From a planning perspective, REIT shares can factor into Business Valuation analyses for companies with significant real estate exposure or investment portfolios. Tax reporting can be complex, so careful recordkeeping and professional guidance are important.
Equity REITs
Equity REITs own and operate income-producing properties. They earn revenue primarily from rents and, to a lesser extent, property sales. These REITs often specialize in sectors such as residential, industrial, retail, healthcare, or infrastructure. Their performance is closely tied to property market fundamentals.
Mortgage REITs (mREITs)
Mortgage REITs invest in real estate debt rather than physical properties. They may hold residential or commercial mortgages and mortgage-backed securities. Returns depend heavily on interest rate spreads and credit conditions. As a result, they can be more sensitive to rate movements and financing markets.
Hybrid REITs
Hybrid REITs combine strategies, holding both properties and mortgage investments. While less common, they aim to diversify income streams by blending rental income and interest income. Their risk and return profile sits between pure equity and pure mortgage REITs.
Beyond these categories, REITs are also classified by listing status, including publicly traded, public non-listed, and private, each with different liquidity, regulatory, and transparency characteristics.
Are REIT dividends taxed differently from stock dividends?
Yes. Most REIT dividends are taxed as ordinary income rather than at the lower qualified dividend rates that apply to many corporate stocks. Portions may be classified as capital gains or return of capital. Investors may qualify for a 20% QBI deduction on eligible REIT dividends, which can reduce the effective tax burden.
Can REITs be held in retirement accounts?
Yes. REITs are commonly held in IRAs, 401(k)s, and other retirement accounts. Holding REITs in tax-advantaged accounts can be efficient because ordinary income dividends can grow tax-deferred or tax-free, depending on the account type. This placement can help mitigate the impact of higher ordinary income tax rates on distributions.
What are the risks of investing in REIT stocks?
Key risks include interest rate sensitivity, real estate market downturns, tenant concentration, and leverage. Because REITs pay out most income, they may rely on external financing for growth. Market volatility can also affect share prices. Sector-specific risks, such as office demand or retail trends, can significantly influence performance.
How do interest rates affect REIT performance?
Interest rates influence REITs in multiple ways. Rising rates can increase borrowing costs and make income-oriented investments like REITs less attractive relative to bonds. However, rate increases tied to economic growth can coincide with stronger property fundamentals. The net impact depends on the pace of rate changes and underlying real estate conditions.
Do REIT investors have voting rights?
Generally, yes. Shareholders in publicly traded REITs typically have voting rights similar to other corporate shareholders. They may vote on matters such as board elections and major corporate actions. However, their influence is usually proportional to share ownership, and day-to-day property decisions remain with management.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Trey Webb, partner in charge of Bennett Thrasher’s Real Estate and Hospitality Tax Group, or call us at 770.396.2200.
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