REIT Investing Guide: How to Earn Real Estate Income Through the Stock Market

Owning real estate has long been one of the most popular ways to build wealth in America. But buying property directly requires a large down payment, ongoing maintenance, tenant management and significant concentration risk in a single building. Real estate investment trusts (REITs) offer an alternative: a way to own a diversified slice of income-producing real estate through the stock market, with the same ease as buying any share.

Created by Congress in 1960 to give everyday investors access to large-scale commercial real estate, REITs have grown into a major part of the US market, spanning everything from apartment complexes and shopping centers to cell towers and data centers. This guide explains how REITs work, the different types, how to evaluate them and how they fit into a portfolio.

What Is a REIT?

A REIT is a company that owns, operates or finances income-producing real estate. To qualify as a REIT under US tax law, a company must meet several requirements, including:

• Investing at least 75% of its total assets in real estate, cash or US Treasuries.
• Deriving at least 75% of gross income from real estate-related sources such as rents and mortgage interest.
• Distributing at least 90% of its taxable income to shareholders as dividends.
• Having at least 100 shareholders.

In exchange, REITs generally don't pay corporate income tax on the income they distribute. That's why REITs are known for high dividend yields — paying out most of their income is a legal requirement. The industry association Nareit provides extensive educational resources on REITs.

Types of REITs

By business model - Equity REITs: Own and operate properties, earning income mainly from rent. This is the largest category. - Mortgage REITs (mREITs): Lend money to property owners or buy mortgage-backed securities, earning income from interest. They're more sensitive to interest rates and credit conditions, and their dividends tend to be more volatile. - Hybrid REITs: Combine both approaches.

By how they're traded - Publicly traded REITs: Listed on major exchanges like the NYSE — liquid and transparent. - Public non-traded REITs: Registered with the SEC but not listed on an exchange; often illiquid with higher fees. - Private REITs: Not registered or traded; generally for institutional or accredited investors.

For most individual investors, publicly traded REITs and REIT ETFs offer the best combination of liquidity, transparency and cost. The SEC has published investor guidance on the risks of non-traded REITs at Investor.gov.

REIT Property Sectors

REITs specialize in specific property types, each with different economics:

• Residential: Apartments, single-family rentals and manufactured housing.
• Industrial: Warehouses and logistics centers, boosted by e-commerce.
• Retail: Shopping centers, malls and net-lease properties.
• Office: Office buildings, which have faced challenges from remote and hybrid work.
• Healthcare: Senior housing, medical office buildings and hospitals.
• Self-storage: Storage facilities with short-term leases.
• Data centers: Facilities housing servers for cloud computing and AI.
• Cell towers and infrastructure: Towers and fiber leased to telecom carriers.
• Hotels and lodging: Highly cyclical, with daily "leases."
• Specialty: Timberland, farmland, billboards and more.

Diversifying across these sectors, or using a broad REIT ETF, reduces exposure to any single property market's challenges.

How to Evaluate a REIT

REITs require some specialized metrics because standard earnings measures can be misleading. Real estate depreciation reduces reported net income, even though well-maintained properties often hold or increase their value.

Funds from operations (FFO) FFO = Net income + Depreciation and amortization − Gains on property sales. FFO is the standard REIT earnings measure, defined by Nareit. Use price-to-FFO instead of the P/E ratio when valuing REITs.

Adjusted funds from operations (AFFO) AFFO goes further, subtracting recurring capital expenditures needed to maintain properties and adjusting for straight-line rent. It's closer to free cash flow and a better gauge of dividend-paying capacity.

Other key metrics - Dividend yield and AFFO payout ratio: Is the dividend sustainable? - Occupancy rate: What percentage of space is leased? - Same-property net operating income (NOI) growth: Are existing properties generating more income? - Lease length and tenant quality: Long leases to strong tenants provide stability. - Debt levels: Net debt to EBITDA and interest coverage. REITs rely heavily on borrowing. - Price to net asset value (NAV): Compares the share price to the estimated market value of the properties.

REITs and Interest Rates

REITs are often treated as "bond proxies" because of their steady dividends, so they're sensitive to interest rates:

• When rates rise, REIT yields look less attractive compared with bonds, borrowing costs increase, and property valuations can come under pressure.
• When rates fall, the opposite tends to occur.

However, the relationship isn't one-to-one. If rates are rising because the economy is strong, REITs may benefit from higher occupancy and rent growth. Our guides on the Federal Reserve and inflation explain these dynamics.

How REIT Dividends Are Taxed

Most REIT dividends are classified as ordinary (non-qualified) dividends and taxed at your regular income tax rate, rather than the lower qualified dividend rate. However, current tax law allows many individual investors to deduct a portion of qualified REIT dividends through the qualified business income deduction. Some distributions may also be classified as return of capital or capital gains. Because of this tax treatment, many investors prefer to hold REITs in tax-advantaged accounts such as IRAs. See our guides to how dividends are taxed and Roth IRAs and 401(k)s.

Ways to Invest in REITs

1. Individual REIT stocks: Allow you to target specific property sectors and management teams, but require research.
2. REIT ETFs and index funds: Provide broad diversification across dozens of REITs at low cost — ideal for most investors. See our ETFs for beginners guide.
3. Real estate mutual funds: Actively managed options, typically with higher fees.
4. Total market index funds: Already include REITs in proportion to their market value.

Risks of REIT Investing

• Interest rate sensitivity, as discussed above.
• Sector-specific challenges, such as office vacancies or retail disruption.
• Leverage: High debt can force asset sales or dividend cuts in downturns.
• Dilution: Because REITs distribute most income, they often issue new shares to fund growth.
• Tax inefficiency in taxable accounts.
• Economic cycles: Hotels and some retail properties are especially sensitive to recessions.

How Much Should You Allocate to REITs?

There's no universal answer. Broad US stock index funds already hold a modest REIT weighting. Some investors add a dedicated REIT allocation — often in the range of 5% to 10% of their stock portfolio — for additional income and diversification. Consider your existing exposure, including any home you own, and keep REITs as part of a diversified portfolio.

Key Takeaways

• REITs let you own income-producing real estate through the stock market.
• They must distribute at least 90% of taxable income, leading to high dividend yields.
• Use FFO and AFFO instead of earnings per share when evaluating REITs.
• REITs are sensitive to interest rates and sector-specific trends.
• REIT ETFs offer easy diversification, and tax-advantaged accounts can improve after-tax returns.