What Is a REIT? How Real Estate Investment Trusts Work

A real estate investment trust (REIT) is a company that owns, operates or finances income-producing real estate — apartments, warehouses, offices, shopping centres, data centres, cell towers — and passes most of the income to shareholders. Buying REIT shares or a REIT fund is a way to earn from property without buying a building or dealing with tenants.

How REITs work

To qualify as a REIT, a company must meet tests set in the tax code, including paying out at least 90% of its taxable income to shareholders each year. In return it generally pays no corporate income tax on what it distributes. That payout requirement is why REIT dividends are usually higher than those of ordinary companies.

Types of REIT

Equity REITs own property and earn rent; they are the most common. Mortgage REITs hold real estate loans and earn interest; they tend to pay more and be more sensitive to interest rates. Publicly traded REITs are listed on an exchange and can be sold any trading day. Non-traded REITs are sold directly, can have high fees and may be hard to sell — the SEC's Investor.gov has an investor bulletin on them.

How REIT dividends are taxed

Most REIT dividends are not qualified dividends, so they are taxed as ordinary income; some portions may be capital gains or return of capital, shown on your Form 1099-DIV. Qualified REIT dividends may be eligible for the 20% qualified business income deduction. Holding REITs in an IRA avoids annual tax on the dividends.

Risks

REIT prices can fall, sometimes sharply, especially when interest rates rise or a property sector struggles, and dividends can be cut. A single REIT is concentrated in one type of property, so broad REIT index funds are the usual way to diversify.

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Next, read P2P Lending and Real Estate Crowdfunding Explained.