Understanding Real Estate Investment Trusts: How REITs Work and How to Invest

By Sophia MartinezLast Updated August 29, 2025

Photo by Joshua Hoehne on Unsplash

Introduction to Real Estate Investment Trusts

Real Estate Investment Trusts, commonly known as REITs , are companies that own or finance income-producing real estate across a variety of sectors. Modeled after mutual funds, REITs allow individual investors to earn a share of income produced through commercial real estate ownership without having to buy, manage, or finance properties directly [3] . This innovative structure has made real estate investing more accessible and liquid than ever before.

What Is a REIT?

According to U.S. regulations, a REIT is a corporation, trust, or association that meets specific qualifying conditions outlined in Section 856 of the Internal Revenue Code [1] . The entity must be managed by trustees or directors and must derive most of its income from real estate-related sources, such as rents or interest on mortgages. REITs are required to distribute at least 90% of their taxable income to shareholders as dividends. This requirement not only benefits investors through steady income but also allows REITs to avoid double taxation at the corporate level [4] .

Types of REITs

There are several main types of REITs, each with distinct characteristics and investment implications [5] :

Equity REITs : These REITs own and often operate income-producing properties. Examples include office buildings, apartments, and shopping centers. Equity REITs generate income mainly through rent collected from tenants.
Mortgage REITs (mREITs) : Instead of owning properties, mREITs finance real estate by purchasing or originating mortgages and mortgage-backed securities. Their income comes from the interest earned on these financial assets.
Hybrid REITs : These combine features of both equity and mortgage REITs, owning properties and holding real estate loans.

REITs can also be classified by sector (such as residential, commercial, healthcare, or industrial) and by their listing status (publicly traded, public non-traded, or private).

How REITs Work

REITs pool capital from many investors to purchase, manage, and sometimes develop real estate assets. Investors buy shares of the REIT, similar to how they would buy stock in a company. This allows them to participate in the profits and losses generated by the underlying real estate portfolio [3] . Shares of publicly traded REITs can be bought and sold on major stock exchanges, providing liquidity that is rare in direct real estate investments [4] .

Benefits of Investing in REITs

REITs offer several notable advantages for investors [3] :

Regular dividend income : By law, REITs must pay out most of their taxable income as dividends, offering attractive yields compared to many other equity investments.
Portfolio diversification : REITs tend to have low correlation with traditional stocks and bonds, meaning they can help reduce overall portfolio risk.
Long-term capital appreciation : The value of the underlying real estate assets may appreciate over time, providing growth potential.
Liquidity : Publicly traded REITs offer the ability to buy and sell shares easily, unlike direct property investments.
Access to professional management : REITs employ experienced property managers, analysts, and executives to oversee their holdings.

Potential Drawbacks and Risks

While REITs present many advantages, investors should be aware of potential challenges [5] :

Dividend taxation : Dividends from REITs are typically taxed as ordinary income, not at the lower qualified dividend rate [4] .
Interest rate sensitivity : Because REITs often finance properties or hold mortgages, their prices can fluctuate with changes in interest rates.
Market volatility : Like all publicly traded securities, REIT prices can be affected by broader market trends.
Property sector risk : Some REITs focus on specific sectors, which can be affected by economic downturns (e.g., retail, hospitality).
Regulatory changes : Tax law and real estate regulation changes can impact REIT operations and investor returns.

Step-by-Step Guide to Investing in REITs

If you’re interested in adding REITs to your portfolio, here’s how you can get started:

Identify Investment Goals : Determine whether you seek income, growth, or diversification. This will help you choose among equity, mortgage, or hybrid REITs.
Research REIT Types and Sectors : Study the specific sectors and geographic focus of different REITs. For example, some specialize in healthcare facilities, while others focus on industrial parks or apartments.
Select a Brokerage or Marketplace : Publicly traded REITs are available through major brokerage platforms. For non-traded or private REITs, you may need to contact specialized investment firms.
Analyze REIT Financials : Review key metrics like Net Asset Value (NAV), Funds from Operations (FFO), and Adjusted Funds from Operations (AFFO) to assess performance [2] .
Review Management and Track Record : Investigate the REIT’s management team and historical performance. Consider reading annual reports and third-party analyses.
Consider Tax Implications : Consult a tax advisor to understand how REIT dividends will impact your tax situation.
Make Your Investment : Purchase REIT shares through your brokerage account. For private REITs, follow the firm’s application process and review all offering documents carefully.
Monitor Your Investment : Track dividends, share price, and relevant sector trends. Diversify across several REITs or sectors to mitigate risk.

For further details on REIT offerings, you can visit brokerage websites like Schwab, Fidelity, or Vanguard, or search for “REIT investments” using trusted financial portals. Ensure that you review current prospectuses before investing.

Real-World Example

Suppose you’re interested in commercial real estate but lack the capital or expertise to buy a shopping center. By purchasing shares in a retail-focused REIT, you effectively own a portion of a diversified portfolio of shopping malls across the country. You receive dividends based on the rental income these properties generate, and your shares can appreciate if the value of the properties increases.

Alternatives to REITs

For those seeking alternative approaches, consider:

Direct property ownership : Requires substantial capital and management expertise.
Real estate mutual funds or ETFs : These funds invest in multiple REITs or property companies, offering broader diversification.
Crowdfunding platforms : Some platforms allow smaller investments in specific real estate projects, though these carry additional risks and may lack liquidity.

Each alternative comes with its own risk and reward profile. Assess which approach aligns best with your financial goals and risk tolerance.

Summary and Key Takeaways

REITs offer a practical, liquid, and income-focused method for individuals to invest in real estate. By understanding the different types, benefits, risks, and steps to invest, you can make informed decisions that support your financial objectives. For those seeking regular income and portfolio diversification, REITs represent a compelling option. Always review the latest market data, consult with financial professionals, and use credible sources when researching REIT opportunities.