A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate across a range of property sectors. Modeled after mutual funds, REITs pool capital from multiple investors, allowing individuals to earn dividends from real estate investments without having to buy, manage, or finance properties directly.
The Legal & Tax Structure
To maintain status as a REIT under U.S. tax law (Internal Revenue Code), an entity must adhere to strict operational guidelines:
- The 90% Dividend Mandate: A REIT must distribute at least 90% of its taxable income annually to shareholders as dividends. Because of this, REITs are exempt from standard corporate income taxes on profits distributed to shareholders, avoiding double taxation.
- Asset & Income Tests: At least 75% of total assets must be invested in real estate, cash, or U.S. Treasuries, and at least 75% of gross income must come from real estate-related sources (such as rents or mortgage interest).
- Ownership Rules: Must be managed by a board of directors or trustees and have a minimum of 100 shareholders after its first year, with no more than 50% of shares held by five or fewer individuals (the “5/50 Rule”).
Main Types of REITs
REITs generally fall into three structural categories based on how they generate income:
| REIT Type | Primary Revenue Source | Underlying Assets |
| Equity REITs | Tenant rent payments. | Direct ownership of real estate (e.g., apartment complexes, industrial warehouses, data centers, retail malls). |
| Mortgage REITs (mREITs) | Net interest margin (interest earned on loans minus borrowing costs). | Mortgages, mortgage-backed securities (MBS), and related debt instruments. |
| Hybrid REITs | Combination of rental cash flows and interest payments. | Both direct physical properties and real estate debt. |
How REITs Trade
REITs are also categorized by how investors access them:
- Publicly Traded REITs: Listed on major stock exchanges (like the NYSE or NASDAQ). They offer high liquidity, enabling investors to buy and sell shares instantly through standard brokerage accounts.
- Public Non-Traded REITs: Registered with the SEC but not listed on public exchanges. They offer less market volatility but carry higher fees and limited liquidity.
- Private REITs: Exempt from SEC registration and unlisted. These are typically accessible only to institutional or accredited investors.
Key Metrics for Evaluating REITs
Standard corporate metrics like Net Income and Price-to-Earnings (P/E) ratios can be misleading for REITs due to heavy real estate depreciation accounting. Instead, use these industry-standard metrics:
- Funds From Operations (FFO): Calculates real operational cash flow by adding back real estate depreciation and amortization and subtracting gains from property sales.
- Adjusted Funds From Operations (AFFO): Refines FFO by deducting recurring capital expenditures (CapEx) required to maintain the properties, providing a clearer look at actual dividend-paying capacity.
- Net Asset Value (NAV): The total market value of the REIT’s property portfolio minus its outstanding liabilities, expressed on a per-share basis.