What Kind of REITs Are There?

REITs come in three types by what they hold: equity REITs own and rent out property, mortgage REITs hold mortgages and mortgage-backed securities, and hybrid REITs hold both. They also come in three types by how they are sold: listed on a stock exchange, registered with the SEC but not traded (public non-traded), or sold privately. The second split usually matters more to you, because it decides how easily you can sell, what you pay in fees, and how much the REIT must disclose.

What is a REIT?

A real estate investment trust (REIT) is a company that owns, and usually operates, income-producing real estate or real estate debt and pays most of its income to shareholders. The SEC lists office buildings, shopping malls, apartments, hotels, self-storage, warehouses, and mortgages among the assets REITs hold. Unlike a developer, a REIT buys or builds property to operate it, not to resell it. Buying REIT shares lets you earn a share of rental or mortgage income without buying a building yourself.

The tax rules that qualify a REIT

A company is a REIT only if it elects that status and meets federal tax tests every year. The main ones:

1. Payout: it must pay dividends equal to at least 90% of its REIT taxable income (excluding net capital gain), under 26 U.S.C. 857.
2. Assets: at the end of each quarter, at least 75% of its total assets must be real estate, cash, or government securities.
3. Income: at least 75% of gross income must come from real estate sources such as rents, mortgage interest, and gains on property sales, and at least 95% from those sources plus other dividends and interest.
4. Ownership: it must have 100 or more owners, and five or fewer individuals may not own more than 50% of its shares during the last half of the tax year.

The asset, income, and ownership tests are in 26 U.S.C. 856. A REIT that meets them is generally not taxed at the corporate level on the income it distributes, so that income is taxed mainly once, when you receive it.

Types of REITs by what they hold

Most REITs specialize in one property type, according to the SEC, so you will see retail, office, residential, healthcare, and industrial REITs.

How mortgage REITs differ

Mortgage REITs earn interest, not rent, and most borrow heavily to do it. The Dallas Fed describes two kinds: agency mREITs, which hold mortgage-backed securities (MBS) guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae, and hybrid mREITs, which add riskier private MBS and real estate loans. At the end of 2019, 39 mREITs held $681 billion in assets and funded 56% of them with repurchase agreements, short-term loans backed by the securities.

That structure ties results to interest rates. When short-term rates rise, borrowing costs rise. When long-term rates rise, the bonds they hold lose value; in 2013, federal regulators on the Financial Stability Oversight Council warned this could set off a run on mREITs' short-term funding. In March 2020, mREITs sold agency MBS to raise cash quickly, which added to market swings. They mainly reduce rate risk with interest rate swaps, contracts exchanging fixed-rate and variable-rate interest payments. Those contracts did not prevent that forced selling. For a closer look, see whether mortgage REITs fit your goals and how financial leverage magnifies gains and losses.

Types of REITs by how they are sold

What are the benefits and risks of REITs?

The benefits and risks depend heavily on which type you buy.

Benefits:

• Income without owning property. REITs pass most of their income to you as dividends, and the SEC notes some REITs pay higher dividend yields than other investments.
• Easy entry and exit for listed REITs. You can buy shares or a REIT fund through a broker, sell on any trading day, and read the REIT's annual and quarterly reports on the SEC's EDGAR system.
• Real estate in a stock and bond portfolio. The SEC notes REITs offer a way to add real estate to an investment portfolio.

Risks:

• Market price swings. Listed REIT shares trade like stocks and can fall with the market or with property values.
• Illiquidity and fees in non-traded REITs. The SEC warns that redemption programs often have significant limits, can pay less than you paid, and may end without notice. Compare the upfront and ongoing fees for your share class in the prospectus.
• Distributions that are not earnings. Non-traded REITs may fund distributions with offering proceeds or borrowing, which lowers the value of your shares.
• Conflicts with outside managers. Non-traded REITs are usually externally managed, and fees tied to acquisitions or assets under management can reward growth over returns.
• Less information in private REITs. Without regular SEC reports, you depend on what the sponsor chooses to disclose.

How are REIT dividends taxed?

REIT payouts can include three kinds of distributions, each reported in a different box of Form 1099-DIV:

1. Ordinary dividends. Most REIT dividends are taxed as ordinary income, not at the lower qualified dividend rates. Individuals can deduct 20% of qualified REIT dividends under section 199A. A 2025 law removed the deduction's scheduled end after 2025, so it continues for 2026 and later years.
2. Capital gain distributions. These are taxed as long-term capital gains no matter how long you held the shares, per IRS Publication 550.
3. Nondividend distributions. Often called a return of capital, these are generally not taxed when paid but lower your cost basis (your purchase cost adjusted for tax purposes), which raises your gain when you sell.

Example: you receive $1,000 of ordinary REIT dividends and are in the 24% bracket. Assume the dividends qualify for section 199A and you meet its requirement to hold the shares for more than 45 days. The 20% deduction is $200 ($1,000 x 20%), so you are taxed on $800, and the federal tax is $192 ($800 x 24%) instead of $240.

For other ways to earn income from real estate debt, see how you can earn income from other people's mortgages.