Key Takeaways:
- REITs allow individuals to invest in income-generating real estate without owning or managing physical properties directly.
- There are several types of REITs—equity, mortgage, and hybrid—each offering different income sources and risk profiles.
- Publicly traded REITs are accessible and liquid, while private and non-traded REITs may offer higher returns but carry greater risk and limited transparency.
- REITs can be suitable for passive investors seeking diversified, dividend-generating exposure to real estate, but they come with risks such as volatility, management control limitations, and tax considerations.
What Is a REIT?
A REIT, or Real Estate Investment Trust, is a company that owns, operates, or finances income-producing real estate. REITs allow individuals to invest in real estate without having to buy, manage, or finance properties themselves.
Most REITs own income-producing properties that are rented out to generate rental income. That income is distributed to investors—typically on a quarterly or monthly basis—depending on the REIT. To maintain their tax-advantaged status, REITs must distribute at least 90% of their taxable income to shareholders as dividends.
According to the IRS, to qualify as a REIT, an entity must:
- Be organized as a corporation, trust, or association.
- Be managed by one or more trustees or directors.
- Have beneficial ownership evidenced by transferable shares (for corporations) or transferable certificates of beneficial interest (for trusts/associations).
- Have at least 100 shareholders (this requirement applies starting with the second taxable year).
- Not be a financial institution (as defined in section 582(c)(2)) or a subchapter L insurance company.
- Not be closely held—meaning that no more than 50% of the value of its shares can be held by five or fewer individuals during the last half of the taxable year (this also applies starting in the second taxable year).
REIT Classifications
REITs have three classifications:
- Publicly Traded REITs – Listed on major stock exchanges, easy to buy and sell, and subject to strict SEC reporting requirements.
- Public, Non-listed REITs (PNLRs) – Registered with the SEC but not traded on an exchange; often sold through broker-dealers, with limited liquidity and share redemption options.
- Private REITs – Not registered with the SEC, available only to accredited investors, typically require higher minimum investments, and provide minimal public disclosure. Typically have stricter holding requirements, making their shares generally illiquid.
REIT Types
REIT investments can be broadly classified into three types based on the types of assets they invest in. Most REITs are publicly traded, while others are private or non-traded. Then, there are the differences between public REITs, non-traded REITs, and private REITs.
Equity REITs
Equity REITs buy and operate income-producing real estate and collect rental income from these properties (e.g., apartments, malls, data centers). This is the most common type. The REIT may sell a property and share the profits with the shareholders, but the income is primarily from rent.
Investors receive partial ownership of the properties under management without any direct control or responsibilities. The equity REIT is responsible for owning, maintaining, managing, and performing other tasks associated with direct property ownership.
Mortgage REITs (mREITs)
Mortgage REITs (mREITs) purchase mortgage debt and mortgage-backed securities, receiving debt payments and interest from these securities. mREITs generate income from interest rather than rent.
They purchase these mortgages from other lenders and, in turn, assume the role of the lender, receiving payments from borrowers who originally took out the loans. Since they deal in liabilities, mREITs don’t own physical properties, but they may hold collateral in the form of liens on these properties.
Hybrid REITs
These companies invest in both equity and mortgage assets, combining both strategies to potentially receive enhanced returns. Hybrid REITs offer diversified exposure, but they may be more challenging to evaluate.
How Do REITs Generate Income?
REITs generate income primarily through the ownership and operation of income-producing real estate, but the exact source of income depends on the type of REIT. The revenue stream determines how investors are paid and how those earnings are taxed.
Equity REITs
- Own and manage income-producing properties such as apartments, offices, retail centers, or industrial facilities.
- Generate most of their revenue from tenant rental payments and lease agreements.
- May also see long-term gains from property appreciation, which can increase the REIT’s net asset value (NAV).
Mortgage REITs
- Do not typically own physical property; instead, they invest in mortgages or mortgage-backed securities.
- Earn income primarily from the interest on these loans.
- Often use leverage to enhance returns, which can also increase risk.
Hybrid REITs
- Combine strategies from both equity and mortgage REITs.
- Generate revenue from a mix of rental income, interest income, and potential property appreciation.
- Offer diversification of income sources, but may be more complex to analyze.
A REIT must distribute at least 90% of its taxable income to shareholders each year in the form of dividends, which may be taxed differently depending on whether they come from rental income, interest income, capital gains, or return of capital.
Key Benefits and Risks of Investing in REITs
REITs offer several benefits and potential risks to investors interested in exploring the real estate market.
Benefits include:
- Accessibility: REITs have a lower minimum investment compared to owning property, and there is no lengthy and complicated paperwork, especially for publicly traded REITs, which can be purchased with as little as the price of a single REIT share.
- Diversification: Investing in REITs allows you to spread risk by purchasing shares in different types of REITs—such as retail, data center, or healthcare REITs—across various geographic regions and property sectors, diversifying your portfolio.
- Liquidity: Buying and selling physical properties can take weeks or months, with marketing, negotiations, closing costs, and legal steps adding time and expense.. Traded REITs can be bought and sold easily on the stock market.
- Professional Management: When you own REIT shares, you essentially own partial ownership of the property, but without the hassles of direct ownership. The REIT management hires experienced managers to handle the tedious tasks of property operations and make informed decisions.
- Dividend Income: REIT management collects rent or mortgage payments and distributes operational profits as dividends to investors. Additionally, REITs are exempt from corporate tax if they comply with IRS rules.
Risks include:
- Limited liquidity: Some REITs, such as Public Non-Listed REITs (PNLRs), are considered illiquid investments. This means investors may have difficulty selling their shares and liquidating their assets quickly because PNLRs are not traded on public exchanges.
- Income suitability: While most investors can invest in public REITs without being accredited, some REITs require investors to meet specific annual income or net worth thresholds.
- Potential poor management of properties: Investing in REITs means that a REIT manager controls the investors’ funds, not the investors themselves. This means investors have minimal control over management processes and must rely solely on the management team for day-to-day decisions.
- Tax implications: In many cases, dividends from REITs are taxed as regular income.
- Limited transparency: Like liquidity, the transparency of the asset value in a REIT can vary depending on its classification. Public REITs are often more transparent than private REITs.
- Volatility: When investing in a publicly traded REIT, you may face the risk of higher volatility. Publicly traded REITs are more susceptible to market fluctuations, and investors can trade these shares at any time.
Is REIT Investing Right for You?
REITs can be suitable for:
- Passive investors
- Retirement-focused portfolios
- Those seeking income-producing real estate exposure without direct ownership
Not ideal for:
- Investors looking for full control
- Those uncomfortable with market volatility
How to Get Started with REIT Investing
Once you’re familiar with the benefits and risks of REITs, the next step is to put that knowledge into action—strategically. The goal is to enter the market confidently while managing potential risks to your overall portfolio.
Here’s a practical approach for first-time REIT investors:
1. Research
Start by gathering the information that’s readily available. Publicly traded REITs are mandated by the SEC to publish their financial statements. These documents contain important information and data that can be used to make informed investment decisions, such as the type of properties and markets they invest in, their management team’s track record, and their quarterly, semi-annual, and annual performance.
2. Select a REIT Type
Evaluate different REITs by comparing historical performance, projected returns, sector focus, and geographic exposure. Consider how each REIT aligns with your investment goals, risk tolerance, and desired income yield.
It’s important to understand the distinction between public and private REITs:
- Publicly traded REITs offer liquidity, transparency, and regular financial disclosures.
- Private REITs and public non-listed REITs (PNLRs) typically provide limited disclosure—sometimes only annually or less frequently—making them harder to evaluate.
- These private vehicles are often limited to accredited investors, defined by the SEC as individuals with a net worth exceeding $1 million (excluding a primary residence) or an annual income above $200,000 ($300,000 for joint income).
3. Open a Brokerage Account Or Consult a Financial Advisor
Publicly traded REITs can be purchased through any online brokerage, just like traditional stocks. Opening an investment account is a straightforward way to begin building your REIT portfolio.
If you’re considering less liquid options like private REITs or PNLRs, it’s wise to consult with a financial advisor. These investments often require higher capital commitments and carry additional risks, so a professional can help assess suitability based on your overall financial strategy.
4. Diversify and Grow
REITs offer flexibility not typically found in direct property ownership. You can diversify across property sectors (e.g., healthcare, industrial, residential) and reinvest dividend income to grow your portfolio over time.
This makes REITs especially well-suited for medium- to long-term investment strategies, including retirement accounts like 401(k)s, IRAs, and Thrift Savings Plans (TSPs). With the ability to scale and reinvest without managing physical properties, REITs are a popular choice for investors seeking passive income and long-term growth.
Explore Passive Real Estate Strategies
REITs provide a straightforward way to access real estate investing with minimal day-to-day involvement. While they offer advantages like consistent income, diversification, and ease of entry, investors should also consider potential risks such as market volatility and liquidity constraints. When thoughtfully selected, REITs can deliver reliable income and long-term exposure to the real estate sector.
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This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC
