What Is a REIT, Really

You can own a slice of a Manhattan office tower, a Texas warehouse full of Amazon boxes, a cell tower in Ohio, and a hospital in Florida, all for the price of one share, bought in the same account you use for stocks. The vehicle that lets you do it is a REIT, a real estate investment trust: a company that owns or finances income-producing real estate and trades on the stock exchange like any other stock.^[1]The pitch you have heard is “become a landlord without the tenants.” That is roughly true. It also hides the one rule that explains everything else about how a REIT behaves.

Here is that rule. To be a REIT, a company must pay out at least 90% of its taxable income to shareholders every year, and most pay out close to 100%.^[2] In return, it owes no corporate income tax. That single trade, no corporate tax in exchange for handing nearly all the profit to you, is the whole personality of the asset. The fat dividend, the strange tax bill, the way REIT prices lurch every time the Federal Reserve moves, the fact that you value them on a metric normal companies do not use: all of it falls out of the 90% rule.

What Actually Makes a Company a REIT

“REIT” is not a vibe, it is a tax status with a checklist, written into the Internal Revenue Code and policed by the Internal Revenue Service (IRS). A company has to clear all of it to qualify, every year. The load-bearing tests are these:^[3]

• Pay out 90% of taxable income. At least 90% goes out as dividends. Fall short and the company loses REIT status and gets hit with regular corporate tax.
• Hold 75% of assets in real estate.At least 75% of the company's assets must be real estate, cash, or US government securities, checked every quarter.
• Earn 75% of income from real estate. At least 75% of gross income has to come from rents, mortgage interest, or property sales, with 95% from those plus other passive income.
• Spread the ownership. A REIT needs at least 100 shareholders, and five or fewer people cannot own more than half of it. No taking a public tax break for a private family holding.

Notice what those tests do together. They force the company to actually be a diversified, income-producing real estate business owned by lots of people, and then they let it escape the corporate tax that a normal company pays before it ever reaches a dividend. A regular stock is taxed twice: once at the company, once when the dividend hits your account. A REIT is taxed once. That is the entire reason the structure exists.

Equity REITs vs Mortgage REITs: Two Very Different Animals

People say “REIT” as if it is one thing. It is two, and the difference is the difference between owning a building and owning the loan on it.

An equity REIT owns and operates actual property. Apartments, malls, warehouses, data centers, cell towers, timberland. It collects rent, and the rent, minus expenses, becomes your dividend. When someone says REIT without qualifying it, this is what they mean, and it is the large majority of the market. A mortgage REIT (mREIT) owns no buildings at all. It lends against real estate or buys mortgage-backed securities, and it earns the spread between its cheap short-term borrowing and the higher-yielding loans it holds. That spread is a leveraged bet on interest rates.

Why the 90% Rule Is the Whole Game

Here is the part most explainers skip, and it is the most useful thing to understand. The 90% payout rule is sold to you as the perk: look at these juicy dividends. But flip it around. If a company is legally required to shovel 90% of its profit out the door, it has almost nothing left to reinvest. A normal company grows by retaining earnings and plowing them back in. A REIT structurally cannot. It has emptied the tank by law.

So how does a REIT grow? It goes back to the market and raises fresh capital, either by borrowing or by issuing new shares. That is the quiet consequence of the whole structure, and it is why REITs are so twitchy about interest rates. When rates rise, the debt a REIT depends on gets more expensive, and the 4% dividend it offers has to compete with a suddenly-attractive 4% Treasury bond. Both push the price down. When rates fall, both reverse. The 90% rule turns a real estate company into something that trades a lot like a bond, and people who buy REITs for “property exposure” are often surprised how much they move with the Fed instead.

The way I think about it, you are trading compounding for income. A REIT hands you cash now instead of quietly growing the pile the way a company that keeps its earnings can. Whether that is good depends entirely on whether you want the cash now.

Why You Value a REIT on FFO, Not Earnings

Try to judge a REIT the way you judge Apple, on earnings per share, and you will get the wrong answer. Accounting rules make you depreciate a building a little each year, as if it were a machine wearing out. But real estate frequently rises in value while the accountants are writing it down. That depreciation is a large, non-cash charge, and it crushes reported net income even though no actual dollar left the building.

The fix the industry uses is funds from operations (FFO): net income, with real estate depreciation added back in and one-time property-sale gains stripped out.^[2]It is a rough measure of the real cash a REIT throws off, and it is what the dividend is actually paid out of. When you read that a REIT “earns” some amount, check whether that is net income or FFO, because they can be wildly different numbers, and only one of them tells you whether the dividend is safe.

The Tax Catch Nobody Mentions in the Ad

The single-layer tax deal is real, but the bill lands on you, and it lands harder than you might expect. Because the REIT paid no corporate tax, most of its dividends are taxed as ordinary income, at rates up to 37%, not the friendlier qualified-dividend rate (15% or 20% for most people) that applies to a normal stock's dividend.

There is a meaningful softener. The Section 199A pass-through deduction lets individual investors deduct 20% of their qualified REIT dividends, which pulls the top effective federal rate down to roughly 29.6%.^[5] Still higher than a qualified dividend, but not brutal. The practical takeaway is simple and worth acting on: REITs are usually best held inside a tax-sheltered account like an IRA or 401(k), where the ordinary-income treatment stops mattering. Hold them in a regular taxable brokerage account and you hand a chunk of that 4% back to the government every April.

Where It Gets Slippery: Non-Traded REITs

One warning before you go shopping. Not every REIT trades on an exchange. Non-traded REITs are registered with the Securities and Exchange Commission (SEC) but do not list, and they are where retail investors get hurt. The SEC itself flags the problems: they are illiquid, so you often cannot sell when you want. Their value estimates can take up to 18 months after the offering closes to even appear. They sometimes pay distributions out of new investors' money rather than actual cash flow. And the upfront fees and commissions typically run 9% to 10%, meaning a tenth of your money is gone before it buys a single square foot.^[1]

A publicly traded REIT or a REIT index fund gives you the same real estate exposure with daily liquidity, transparent pricing, and fees measured in basis points instead of double-digit percentages. I struggle to think of a good reason for an ordinary investor to touch the non-traded version.

What I'd Actually Do

If you want real estate in your portfolio without becoming a landlord, a low-cost REIT index fund, held in a retirement account, gets you 90% of the way there with none of the drama. It gives you rent from thousands of properties, it rebalances itself, and it sidesteps the tax drag. Compare that to what landlords actually clear after vacancies, repairs, and 2am phone calls, and the REIT starts looking less like a compromise and more like the reasonable default. It slots in next to an index fund and a bond fund as the third leg of a boring, effective portfolio.

Just go in clear-eyed about the trade you are making. A REIT is not a magic real estate money printer. It is a company that the law forces to pay you almost everything it makes, and that one rule is the source of the good parts and the annoying parts alike. Once you see the 90% rule sitting underneath all of it, every other REIT quirk stops being a surprise.