1. What Is a REIT?
A REIT (Real Estate Investment Trust) is a company that owns, operates, or finances income-producing real estate. Think of it as a mutual fund for real estate—you buy shares on a stock exchange, and the REIT uses that capital to invest in properties.
REITs were created by Congress in 1960 to give everyday investors access to large-scale, income-producing real estate that was previously only available to institutions and the wealthy. Today, an estimated 150 million Americans own REITs, either directly or through retirement accounts.
The Core Idea
When you buy shares of a REIT, you're buying a piece of a portfolio of real estate— office buildings, apartment complexes, warehouses, data centers, cell towers, or even hospitals. You collect dividends from the rental income and benefit from property appreciation.
The key difference from a regular stock: REITs must distribute at least 90% of their taxable income to shareholders as dividends. This makes them high-yield investments but limits their ability to retain earnings for growth.
2. How REITs Work
The 90% Distribution Rule
To qualify as a REIT and avoid corporate-level taxation, a company must distribute at least 90% of its taxable income to shareholders annually. This "pass-through" structure is similar to a partnership—the company doesn't pay corporate tax; instead, shareholders pay tax on the dividends they receive.
This creates the high dividend yields REITs are known for (typically 3-8%), but it also means REITs can't grow purely through retained earnings like other companies. They must constantly raise capital—issuing new shares or taking on debt—to acquire properties.
The Growth Engine: Cost of Capital
A REIT's ability to grow depends on the spread between its cost of capital (what it pays to raise money) and the cap rate (the yield on properties it buys).
Example: A REIT raises capital at 5% (blended cost of debt and equity) and buys properties yielding 7%. That 2% spread is the "accretive" growth that benefits shareholders.
When interest rates spiked in 2022-2024, this spread compressed for many REITs, slowing acquisitions. As rates stabilized in 2025, the growth engine restarted.
Measuring REIT Performance
REITs use different metrics than typical stocks:
- FFO (Funds From Operations): Net income + depreciation. The standard earnings metric for REITs, since depreciation is a non-cash expense.
- AFFO (Adjusted FFO): FFO minus capital expenditures. A closer approximation of "true" cash flow available for dividends.
- NAV (Net Asset Value): The estimated value of the underlying properties minus debt. Useful for valuation.
3. Types of REITs
Equity REITs vs Mortgage REITs
There are two fundamentally different types of REITs:
| Type | What They Own | Income Source | Risk Profile |
|---|---|---|---|
| Equity REITs | Physical properties | Rent from tenants | Moderate |
| Mortgage REITs (mREITs) | Mortgages / MBS | Interest payments | High (leveraged) |
Equity REITs (Most Common)
Equity REITs own and operate income-producing real estate. They collect rent, pay expenses, and distribute the profits. When you think of REITs, you're probably thinking of equity REITs. Examples: Prologis (warehouses), Realty Income (retail), AvalonBay (apartments).
Mortgage REITs (mREITs) — Proceed with Caution
Mortgage REITs don't own buildings—they own debt. They borrow money short-term, buy mortgage-backed securities, and profit from the spread. They often sport eye-popping yields (10-15%), but there's a reason.
mREITs also use extreme leverage (7x+ in some cases) and are highly sensitive to the yield curve. When short-term rates exceed long-term rates (inverted curve), their business model breaks.
4. REIT Sectors: A Deep Dive
"Real estate" is not a single asset class. A retail landlord shares little in common with a data center operator beyond the REIT tax structure. Understanding these differences is essential for evaluating REITs.
| Type | What It Is | Representative | Pros | Cons |
|---|---|---|---|---|
| Net Lease Retail | Single-tenant retail on triple-net leases | Realty Income (O) | Defensive, monthly dividends, recession-resistant | Rate-sensitive, low growth, tenant concentration |
| Industrial | Warehouses & distribution centers | Prologis (PLD) | E-commerce tailwind, rent growth, development upside | Cyclical, supply gluts in some markets, tariff exposure |
| Data Centers | Facilities housing servers for cloud/AI | Equinix (EQIX) | AI demand, high switching costs, secular growth | High valuation, power constraints, capital intensive |
| Cell Towers | Wireless infrastructure for carriers | American Tower (AMT) | Operating leverage, 5G growth, long-term contracts | Carrier consolidation risk, leverage, international exposure |
| Residential | Apartments, student housing, SFR | AvalonBay (AVB) | Housing shortage, closest to direct rental investing | Rent control risk, supply waves, cost-of-living migration |
| Healthcare | Hospitals, MOBs, senior living | Welltower (WELL) | Aging population tailwind, demographic certainty | Labor costs, reimbursement policy risk, slow-moving thesis |
| Office | Office buildings (trophy & commodity) | Boston Properties (BXP) | Deep value, high yields, potential recovery play | WFH structural shift, high leverage, obsolescence risk |
| Mortgage (mREITs) | Mortgage-backed securities, not property | Annaly (NLY) | High current yield (10-14%), liquidity | Book value erosion, rate sensitivity, leverage risk ⚠️ |
Click any sector to jump to details. Mortgage REITs own debt, not property—evaluate on total return, not yield alone.
Net Lease Retail
Net lease retail REITs own single-tenant properties—convenience stores, pharmacies, fast food restaurants—leased to national brands on long-term "triple-net" (NNN) leases. In a triple-net lease, the tenant pays property taxes, insurance, and maintenance; the REIT simply collects rent.
Representative: Realty Income (NYSE: O)
The sector bellwether, often called "The Monthly Dividend Company." Owns 15,000+ freestanding retail properties leased to tenants like 7-Eleven, Walgreens, and Dollar General on 10-20 year leases.
Business model: An arbitrage game. Realty Income issues debt at ~5-6% and acquires properties yielding ~7-8%. The spread is the profit. Because spreads are thin, volume is critical—they must acquire billions annually to grow.
Key Risks:
- Interest rate sensitivity: Long-term fixed leases behave like bonds. When rates rise, the present value of future rents falls, and stock prices typically decline.
- Tenant credit risk: Concentrated exposure to specific industries (pharmacies, dollar stores). Systemic issues in one industry create headline risk.
- Scale problem: With 15,000+ properties, finding enough acquisitions to move the needle requires geographic expansion (Europe) and new asset classes (casinos).
Market behavior: Defensive in downturns—during 2008, Realty Income fell only ~8% vs the S&P 500's ~37% drop, and maintained its dividend. However, it tends to lag in bull markets as investors rotate to higher-growth sectors.
Industrial / Logistics
Industrial REITs own warehouses, distribution centers, and fulfillment hubs that power the global supply chain—the backbone of e-commerce and modern inventory management.
Representative: Prologis (NYSE: PLD)
The largest industrial REIT globally with 1.3+ billion square feet. Unlike passive landlords, Prologis builds facilities from scratch, targeting "development yields" higher than market cap rates—creating immediate value upon completion.
Beyond real estate: Prologis has evolved into an energy company—installing solar arrays on warehouse roofs and selling power. They're also converting logistics sites into data centers to capture value arbitrage between industrial rents and data center power leases.
Key Risks:
- Economic cyclicality: Industrial demand is highly correlated with GDP and consumer spending. If the economy slows, shipping volumes drop.
- Supply gluts: Developers overbuilt during the pandemic boom. Certain submarkets face vacancy pressure that limits rent growth.
- Tariff exposure: Trade barriers that reduce import volumes directly impact logistics networks near ports and intermodal hubs.
Market behavior: Higher volatility than defensive sectors. During the 2008 crisis, the predecessor to modern Prologis collapsed 96% due to excessive leverage. The modern company has an A-rated balance sheet, but shares still fell ~43% during the 2022 inflation shock due to valuation compression.
Data Centers
Data center REITs own secure, power-dense facilities that house servers for cloud computing, AI workloads, and enterprise IT—often called the "infrastructure of the AI era."
Representative: Equinix (NASDAQ: EQIX)
The global leader in "retail colocation" and network interconnection. Unlike "wholesale" operators who lease empty shells to hyperscalers (AWS, Azure), Equinix creates ecosystems where thousands of companies physically connect their servers within the same building.
The moat: Once a bank has cabled its servers to 50 trading partners inside an Equinix facility, moving to a competitor is logistically nightmarish. This network effect creates high switching costs and allows premium pricing.
Key Risks:
- Power constraints: The biggest limitation on growth is access to electricity. Grid capacity in major hubs is tapped out, limiting new builds.
- Capital intensity: Cooling systems, backup generators, and security require constant heavy CapEx, dragging on free cash flow.
- Valuation risk: Often trades at 20-30x AFFO due to AI narrative. Little room for error—any growth slowdown can trigger sharp corrections.
Market behavior: Behaves more like a tech stock than a traditional REIT. Tends to outperform during tech booms but can be volatile when rates rise (which discount future growth). Has high correlation with the NASDAQ.
Cell Towers
Cell tower REITs own the vertical steel structures that act as the nervous system for wireless networks. They own the steel and land; carriers (AT&T, Verizon, T-Mobile) own the antennas and equipment.
Representative: American Tower (NYSE: AMT)
A global giant with operations in the US, Africa, India, and Latin America. The economics are attractive due to operating leverage: building a tower costs a fixed amount, but adding a second or third tenant costs almost nothing while generating pure profit.
Growth driver: 5G "densification." As mobile data usage explodes, carriers must install more equipment on existing towers. AMT has also expanded into data centers through its CoreSite acquisition.
Key Risks:
- Carrier consolidation (churn): When carriers merge (e.g., Sprint/T-Mobile), they decommission overlapping sites, creating revenue headwinds.
- International exposure: Unlike US-centric Crown Castle, AMT has heavy exposure to developing markets—offering higher growth but currency risk, political instability, and operational challenges.
- Leverage: Tower REITs historically run with higher leverage. AMT spent much of 2025 deleveraging to protect its investment-grade rating.
Market behavior: A long-term compounder (~13x returns since IPO), but interest-rate sensitive due to leverage. The 2022-2023 rate surge hit the stock hard; it began recovering as rates stabilized.
Residential / Multifamily
Residential REITs own apartment buildings, student housing, and single-family rentals—the sector most comparable to direct rental property investment.
Representative: AvalonBay Communities (NYSE: AVB)
A blue-chip developer and operator focused on high-barrier-to-entry coastal markets (California, New York, Boston). Their strategy revolves around "value creation through development"—building new communities at higher yields than buying existing buildings.
Geographic focus: Operates in markets where it's hard to build due to regulations and land constraints. This proved defensive when Sun Belt markets were flooded with new apartments.
Key Risks:
- Rent control: Operating in coastal "blue" states exposes AVB to strict rent control legislation that can limit NOI growth.
- Cost of living exodus: Long-term risk of wealth migration to lower-tax Sun Belt states, though AVB is diversifying.
- Supply waves: A record number of apartments started in 2022-2023 are delivering now, particularly in Sun Belt markets.
For rental property investors: Multifamily REITs like AVB are the closest public-market equivalent to owning an apartment building. Comparing their returns and valuations to your local market can help benchmark direct investment opportunities.
Healthcare / Senior Housing
Healthcare REITs own hospitals, medical office buildings (MOBs), and senior living facilities, with demand often tied to demographic trends like the aging population.
Representative: Welltower (NYSE: WELL)
A leader in senior housing operating (SHO) portfolios. Unlike triple-net leases where the REIT just collects rent, Welltower uses the RIDEA structure—sharing in the operational profits of facilities. This aligns them with operators and allows upside capture when rents rise.
Demand driver: The "Silver Tsunami" of aging Baby Boomers. The 80+ population is growing steadily, driving demand for senior living. Meanwhile, high rates have halted new construction.
Key Risks:
- Labor costs: Senior housing is labor-intensive. Nursing wage spikes or labor shortages directly compress margins under the RIDEA model.
- Government reimbursement: While senior housing is often private-pay, skilled nursing and hospitals rely on Medicare/Medicaid. Reimbursement changes are a perpetual political risk.
- Demographic timing: The demographic thesis requires patience—population aging is a slow-moving trend, not a sudden spike.
Office
Office REITs own office buildings—the most challenged property type in the current environment due to the work-from-home shift.
The Bifurcation
The office market is not uniform. There's a massive split between "Trophy" assets (modern, amenity-rich, prime locations) which continue leasing, and commodity B-class office space facing potential obsolescence.
| Metric | Boston Properties (BXP) | Highwoods (HIW) |
|---|---|---|
| Focus | Coastal Gateway (NY, SF, Boston) | Sun Belt (Nashville, Raleigh, Atlanta) |
| Strategy | Vertical Trophy Campuses | Suburban/CBD mix in growth markets |
| Risk Factor | Tech sector weakness; high leverage | Supply in Sun Belt markets |
Key Risks:
- Structural demand impairment: Work-from-home has permanently reduced office space needs for many companies.
- High leverage: Many office REITs carry elevated debt levels (some >8x Debt/EBITDA), restricting flexibility.
- Obsolescence: Older, less-amenitized buildings may not find tenants at any price, requiring costly repositioning or demolition.
Mortgage REITs (mREITs)
Mortgage REITs don't own buildings—they own debt. They borrow money short-term, buy mortgage-backed securities (MBS), and profit from the interest rate spread.
Representative: Annaly Capital (NYSE: NLY)
The largest mREIT by market cap. Primarily invests in agency MBS (backed by Fannie Mae/Freddie Mac). Often yields 10-14%, attracting income-hungry investors.
Business model: Borrow at short-term rates, invest in longer-term mortgages, pocket the spread. Uses significant leverage (typically 5-7x) to amplify returns.
Key Risks:
- Interest rate sensitivity: Rising short-term rates squeeze the spread. An inverted yield curve can make the business model unprofitable.
- Book value erosion: Many mREITs show declining book value over time. That 12% yield may partly be a return of your own capital.
- Leverage risk: 5-7x leverage means small losses are magnified. Margin calls can force asset sales at the worst times.
- Prepayment risk: When rates fall, homeowners refinance, returning principal early and forcing reinvestment at lower rates.
5. REITs vs Direct Rental Property
This is the question every real estate investor faces: should I buy REIT shares or actual property? The answer depends on what you value most.
| Factor | REITs | Direct Rental |
|---|---|---|
| Passive Income | Truly hands-off | Active management required |
| Liquidity | Instant (sell shares anytime) | Months to sell; 6-10% costs |
| Diversification | Instant (thousands of properties) | Concentrated in 1 asset |
| Minimum Investment | One share | $50K-$100K+ (down payment) |
| Tax Benefits | Limited (ordinary income) | Depreciation, 1031 exchanges |
| Leverage | Indirect (corporate level) | Personal mortgages (80% LTV) |
| Control | None | Full (tenants, renovations) |
| Historical Return | ~9.7% (CEM study) | ~7.7% (CEM study) |
The Return Paradox
Studies show public REITs have historically outperformed private real estate by about 2 percentage points annually (~9.7% vs ~7.7%). This surprises many investors who assume "sweat equity" from hands-on management should yield higher returns.
The explanation: REITs benefit from institutional-grade management, lower cost of capital (investment-grade debt), and operational scale that individual landlords can't match. The "illiquidity premium" private investors expect often doesn't materialize.
That said, these studies measure pre-tax returns. Direct rental property offers significant tax advantages—depreciation deductions, 1031 exchanges, and more—that can narrow or even reverse the gap on an after-tax basis.
The Tax Advantage of Direct Ownership
Despite lower headline returns, direct rental property wins decisively on taxes:
- Depreciation: Deduct the building's value over 27.5 years, often creating "paper losses" that shelter cash flow from taxes. See our Tax Guide.
- 1031 Exchanges: Defer capital gains indefinitely by rolling proceeds into new property. See our 1031 Exchange Guide.
- Step-up in Basis: Heirs inherit at fair market value, potentially eliminating all deferred gains.
REITs offer none of these. You can't depreciate REIT shares, and you can't 1031 exchange them. Dividends are taxed as ordinary income.
The Leverage Superpower
Direct property offers personal leverage that REITs can't match:
Example: You buy a $500K rental with $100K down (80% LTV). If the property appreciates 5%, you gain $25K—a 25% return on your $100K equity. That's 5x leverage.
With REITs, you'd need margin loans (risky, callable) to achieve similar leverage. The 30-year fixed mortgage is a unique tool for individual real estate investors.
6. When to Choose Each
Choose REITs If You...
- Want truly passive income with zero management
- Need liquidity (ability to sell quickly)
- Have limited capital (under $50K to invest)
- Want instant diversification across property types and geographies
- Are investing in a tax-advantaged account (IRA/401k)
Choose Direct Rental Property If You...
- Want to minimize taxes through depreciation and 1031 exchanges
- Can use leverage (mortgages) to amplify returns
- Want control over property decisions and tenant selection
- Have local market knowledge to find good deals
7. Key Takeaways
- REITs = passive, liquid, diversified—ideal for hands-off investors and tax-advantaged accounts
- Direct rental = tax advantages, leverage, control—better for hands-on investors who can use depreciation and 1031 exchanges
- Sector selection matters—each REIT sector has distinct drivers, risks, and cycles. "Real estate" is not one asset class