Your complete guide to Real Estate Investment Trusts. Learn about different property sectors, key valuation metrics like FFO, and the top REITs to consider for your portfolio.
A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. Modeled after mutual funds, REITs pool the capital of numerous investors. This makes it possible for individual investors to earn dividends from real estate investments—without having to buy, manage, or finance any properties themselves.
To qualify as a REIT and avoid paying corporate income tax, a company must distribute at least 90% of its taxable income to shareholders annually in the form of dividends. This unique structure makes REITs one of the highest-yielding asset classes in the stock market.
The vast majority of REITs are equity REITs. They own and operate income-producing real estate (like apartments, malls, or office buildings). Their revenue comes primarily from collecting rent.
mREITs don't own physical property. Instead, they provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS). They earn income from the interest on these investments.
As the name suggests, hybrid REITs use the investment strategies of both equity and mortgage REITs, owning physical properties while also holding commercial mortgage loans.
When you invest in equity REITs, you are typically investing in a specific sector of the real estate market. The major sectors include:
Traditional stock metrics like the P/E ratio are not very useful for evaluating REITs. Because real estate is heavily depreciated for tax purposes, a REIT's Net Income will look artificially low. Instead, investors use specific real estate metrics:
FFO is the standard metric used to measure a REIT's operating performance. It takes Net Income, adds back depreciation and amortization, and subtracts any gains from the sale of properties.
AFFO goes a step further by subtracting recurring capital expenditures (maintenance costs required to keep properties running). It is often considered a more accurate measure of a REIT's true cash flow and its ability to pay dividends.
NAV estimates the total market value of a REIT's properties minus its liabilities. If a REIT is trading below its NAV, it may be considered undervalued.
While a high dividend yield is attractive, it's crucial to ensure the dividend is safe. Look at the AFFO Payout Ratio (Dividends per share divided by AFFO per share). A ratio below 80-85% generally indicates a safer dividend.
Because REITs don't pay corporate tax, the tax burden is passed onto the investor. Most REIT dividends do not qualify for the lower "qualified dividend" tax rate. Instead, they are taxed as ordinary income at your regular marginal tax bracket.
However, under the Tax Cuts and Jobs Act, investors can deduct 20% of their REIT dividend income (the Qualified Business Income deduction), which lowers the effective tax rate. Even so, many investors prefer to hold REITs in tax-advantaged accounts like a Roth IRA.
Buying a fund like Vanguard Real Estate ETF (VNQ) gives you instant diversification across hundreds of REITs in various sectors. It requires minimal research and reduces single-company risk, making it ideal for passive investors.
Buying specific companies allows you to target high-growth sectors (like data centers) or avoid struggling sectors (like office space). You can also seek out higher starting yields, but this requires active research and carries higher risk.
How does buying a REIT compare to buying a rental property yourself?
Here is a list of prominent REITs across various real estate sectors. Note: This is for educational purposes and not a recommendation to buy.
| REIT Name | Ticker | Sector |
|---|---|---|
| Prologis | PLD | Industrial |
| American Tower | AMT | Cell Tower |
| Equinix | EQIX | Data Center |
| Public Storage | PSA | Self-Storage |
| Realty Income | O | Retail (Net Lease) |
| Welltower | WELL | Healthcare |
| Simon Property Group | SPG | Retail (Malls) |
| AvalonBay Communities | AVB | Residential (Apartments) |
| Digital Realty Trust | DLR | Data Center |
| Extra Space Storage | EXR | Self-Storage |
| Mid-America Apartment Communities | MAA | Residential (Apartments) |
| Alexandria Real Estate Equities | ARE | Office (Life Sciences) |
| Invitation Homes | INVH | Residential (Single-Family) |
| W.P. Carey | WPC | Diversified Net Lease |
| Crown Castle | CCI | Cell Tower |