REITs 101: A Guide for Beginner Investors

Buying real estate can be expensive.

From down payments to taxes, repairs, and inspections, you might need $50,000 just to get started in today’s market. And if you want to invest in commercial real estate, the number may be even higher.

Luckily, you don’t need huge sums of money to invest in real estate without actually buying. Plus, you can avoid dealing with tenants, repairs, constructions, and the headaches of owning property.

Instead, you can just invest in a REIT.

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What Is a REIT?

Real estate investment trusts (REITs) are companies that own and operate real estate, or invest in real estate loans. 

These companies pass along most of the real estate income and profits to investors — law requires REITs to distribute 90% of their earnings to shareholders.

In addition to distributing a majority of their earnings to shareholders, REITs must derive at least 75% of their income from real estate activities, and invest 75% of their assets in real estate investments. 

When you invest in a REIT, you earn dividends from all of the properties owned by the REIT through monthly rents or from monthly interest earned by real estate loans provided by the REIT.

They offer you exposure to the real estate market without the huge upfront cost.

REIT tax treatment

REITs don’t pay corporate income tax on the earnings distributed. Instead, they pass the tax burden along to investors. 

That means the income you earn from REITs is subject to income tax, and REIT dividends aren’t qualified — the dividends are taxed at ordinary income tax rates instead of the preferential capital gains rates.

For example, if you invest in a dividend-paying stock that pays out qualified dividends, you will pay capital gains rates from 0% up to 20% maximum. 

But nonqualified dividends (like the ones that REITs pay) could result in up to 37% income taxes.

Because of this potential tax burden, it’s better to hold REITs within tax-advantaged accounts, such as an IRA or 401(k). 

There is a 20% potential tax deduction available on the income earned from a REIT, according to the IRS, but that means 80% of it is still taxable at your regular tax rate.

Types of REITs

There are multiple types of REITs, based on the types of investments held within each. 

Equity REITs

Equity REITs are companies that own and operate commercial real estate. They earn money from both collected rents and property appreciation. 

In most cases, the primary income-earning activity from equity REITs is monthly rent, but many REITs will sell off a property if sufficient equity has built up. This can result in a larger payout for investors when a property is sold off.

Equity REITs can hold commercial real estate, residential real estate, or a mix of both. 

The goal for most equity REITs is steady income and growth. But the growth may take time, and the fund may have to spend money on improvements to the property, which can impact returns. 

Equity REITs have a higher potential return than most REITs, but also have a much higher risk of loss.

Debt REITs

Debt REITs are companies that primarily invest in real estate loans for both commercial and residential properties.

These REITs help real estate investors finance the purchase or improvement of a property, then benefit from monthly interest payments.

Debt REITs include investments in mortgages, mezzanine loans, and preferred equity structures. 

Sector REITs

You can also invest in REITs that invest within a specific real estate sector. Here are a few examples:

• Retail REITs own commercial real estate such as malls, shopping centers, and outlets. Money is made from rents and overall price appreciation.
• Residential REITs own single- or multi-family properties and make money from rents collected and price appreciation. Residential real estate is sometimes seen as more stable than commercial because people always need somewhere to live.
• Office REITs own office buildings and earn money from short- and long-term leases to tenants.
• Healthcare REITs own properties like hospitals, nursing homes, and adult care facilities. Rents are collected from lease agreements, but the performance is highly dependent on the ‘health’ (pun intended) of the medical sector and health insurance funding.

Are REITs a Good Investment?

REITs can be a great investment and add diversity to your portfolio, but they can also underperform and have more volatility than other asset classes. 

Pros

• Low up-front cost: Many REITs can be bought and sold like stocks or ETFs — and you only need enough money to buy a single share to get started. For example, American Tower Corporation (AMT) costs roughly $220 a share as of August 2024. 
• No landlord headaches: With REITs, the underlying company you’re invested in handles tenant placement, issues, repairs, and other landlord hassles.
• Diversification: Investing in real estate through REITs helps spread your risk to a longstanding asset class with a great track record.
• Income: You’ll get monthly or quarterly dividends from rent payments. This can be great passive income and help bolster retirement income as well.

Cons

• Tax-inefficient: Dividend income from REITs is taxed at the highest rate, with only a small 20% potential discount in some cases.
• Not a tangible investment: While holding a REIT lets you benefit from real estate investment activities, you can’t materially affect the investment. With traditional real estate investing, you can put in sweat equity, raise rents, and affect your returns directly.
• High fees: Many REITs charge high sponsor fees and only distribute profits after paying for management, improvements, debt service, and other costs. This can hurt your overall returns.

READ MORE: How To Tell If an Investment Is Too Good To Be True

How To Invest in REITs for Beginners

If you’re just getting started and want to add REITs to your investment portfolio, the easiest way is to find a publicly traded REIT and invest through a reputable broker. 

Most large online brokers offer access to REITs and won’t charge any trading fees to invest in them.

You’ll first need to sign up for a brokerage (or retirement) account through an online broker like Fidelity, Schwab, or Vanguard. 

Once the account is opened, you’ll need to connect it to your bank account and transfer funds to invest. You can then choose which REITs to invest in.

While most brokers allow you to purchase REITs for the price of a single share, others may offer fractional-share investing. This means you can invest as little as $10 (or less) and buy a fraction of a REIT share. Apps like Webull, M1 Finance, Robinhood, Schwab, and Fidelity offer fractional shares.

You can also invest in REITs through a dedicated platform like Fundrise, which sells fractional shares of REITs starting at just $10. (Note that the eREITs through Fundrise aren't publicly traded like REITs through a brokerage.)

READ MORE: Fundrise Review: Invest in Real Estate for $10

Once you purchase a REIT, it’s a good idea to keep an eye on the overall performance. You may be able to reinvest your REIT dividends to buy more shares.

Finally, it’s important to review your overall asset allocation to ensure you are well-diversified. While adding REITs to the mix can help, make sure it’s within an overall investment plan that evaluates your risk tolerance and investment goals.

READ MORE: Long-Term vs. Short-Term Investment Strategies

FAQs

How much money do you need to invest in a REIT?

REITs can be bought through most online brokers for the price of one share. Many REITs are priced from $50 to $200 per share, but the price will vary. 

Some brokers also offer fractional-share investing, allowing you to invest just a few dollars to buy a portion of a REIT share.

What is a good return on a REIT?

REIT returns vary by type of REIT, investment timeline, and the overall market. But owning a fund that holds a large number of REITs can give some insight into REIT returns. 

For example, holding Vanguard’s Real Estate Index Fund since 2001 returned about 8.70% annually over the last 23 years. 

TL;DR: REITs for Beginners

REITs can be a great way to get into real estate investing, without having to be a landlord or put down a large amount of money. Instead, REITs handle all the ownership aspects for you, and you can collect dividends from rent or property appreciation.

But REITs also come with tax consequences and potentially high fees. Make sure any REIT investments you make fit your risk tolerance and complement other assets in your portfolio.

For more investing advice at any stage, check out these episodes of the Erika Taught Me podcast:

• The Missing Piece in 99% of Financial Advice
• You’ll Want to Fire Your Financial Advisor After Hearing This
• Investing Advice from the Most Powerful Woman on Wall Street

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