A real estate investment trust (REIT) is a company that owns, operates or finances income-producing real estate. Buying shares of a REIT lets you invest in property such as offices, apartments, warehouses or data centers without buying a building yourself, and many REITs trade on the stock market like any other stock.
How REITs work
To qualify as a REIT in the US, a company must meet several rules, including investing mainly in real estate and paying out at least 90% of its taxable income to shareholders as dividends. In return, it generally avoids corporate income tax on the income it distributes. That's why REITs are known for high dividend yields.
Main types of REITs
- Equity REITs: own and manage properties and earn rent. The most common type.
- Mortgage REITs: lend money for real estate or buy mortgage securities, earning interest. Usually higher yields and more sensitive to interest rates.
- By property type: retail, residential, office, industrial and warehouses, health care, self-storage, data centers, cell towers and more. Each sector has its own economics.
How to evaluate a REIT
Standard earnings measures don't work well for REITs, because property depreciation is a large accounting charge even though buildings often hold or gain value. Instead, investors use:
- Funds from operations (FFO): net income with real estate depreciation added back and gains from property sales removed. Price ÷ FFO per share is the REIT version of the P/E ratio.
- Adjusted FFO (AFFO): FFO minus recurring maintenance spending, a closer measure of cash available for dividends.
- Occupancy rates and lease lengths.
- Debt levels, since REITs borrow heavily. See the debt-to-equity ratio.
- Dividend coverage: dividends compared with AFFO. See dividend payout ratio.
Benefits
- High, regular dividend income.
- Real estate exposure with small amounts of money and easy buying and selling.
- Diversification beyond regular companies. See how to diversify.
Risks
- Interest rate sensitivity: rising rates raise borrowing costs and make REIT yields less attractive compared with bonds. See how interest rates affect stocks.
- Sector trends: for example, changes in how people shop or work can hurt certain property types for years.
- Taxes: most REIT dividends are taxed as ordinary income rather than at lower qualified-dividend rates, so many investors hold REITs in tax-advantaged accounts. See capital gains tax on stocks.
A REIT ETF is a simple way to spread money across many properties and sectors. See what is an ETF, and model REIT income with the dividend calculator.
This article is educational and not investment advice.
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