What are REITs?
A REIT is a type of company that owns—and in most cases operates—income-producing real estate or related assets. Investors can participate in the gains and losses of these real estate assets by purchasing shares of a REIT, often on traditional stock exchanges. REITs offer a liquid method of real estate investing with special tax considerations that allow them to typically yield higher dividends.
How are REITs structured and taxed?
REITs are structured as a corporation and thus are not typically taxed at the entity level. Generally, they're required to invest in real assets and derive most of their income from real estate activities, including rents from properties and interest from mortgages.
How do REIT dividends get taxed?
90% of a REIT's annual taxable income must also be paid in dividends which, when combined with a structure that avoids double taxation, allows REITs to typically pay out a higher dividend rate than many equity investments. Dividends received from REIT holdings are taxed as regular income. Learn more about how a Real Estate Investment Trust works.
What are some potential benefits and risks of investing in REITs?
Benefits of REITs
Potential for higher yield
REITs typically pay higher dividends than common equities due to the cash-generating nature of real estate properties combined with their favorable tax structure.
Accessibility
REITs are typically listed on a national exchange and provide investors considerable liquidity. These securities invest in a portfolio of commercial real estate assets that are not typically available to retail investors.
Diversification
REITs can provide diversification by following the real estate cycle, which historically spans a decade or more—longer than the typical stock market cycle of 6 to 7 years on average.
Inflation hedging
REITs can serve as an effective hedge against rising inflation rates. In particular, REITs with commercial holdings frequently have agreements that allow them to raise rents in tandem with inflation.
Drawbacks of REITs
Real estate market fluctuations
REITs closely follow the overall real estate market and are subject to much of the same risks, including fluctuations in property value, leasing occupancy, and geographic demand.
Interest rates
Real estate is typically very sensitive to changes in interest rates, which can affect property values and occupancy demand.
Occupancy rates
In order to maintain the expected payouts, REITs must maintain certain occupancy levels. This closely ties in with the amount of rent that these properties are able to command. Lower rents and occupancy rates may negatively impact REITs.
Geographic focus
REITs can have a narrow geographic focus where the majority of the property is located in a particular area or region.
Business dependency
REITs can be highly susceptible to changes in the underlying business or industry that leases the properties, especially if sector-specific.
Schwab's perspective on REITs
REITs offer a number of attractive attributes such as income and diversification, and they have historically delivered strong results and provide attractive income relative to other asset classes. Historically, they have also been a good hedge against inflation; however, investors considering REITs should know they are often low-growth investments with little capital appreciation.
Common types of REITs
REITs fall into two main categories: mortgage REITs and equity REITs. Both types are used by investors for dividend income, but below are some key highlights and differences.
Mortgage REITs (mREITs)
- Invest in mortgages and mortgage-backed securities
- Earn income mainly from interest payments
- Used by investors for dividend income, typically with higher yields than equity REITs but also more sensitive to interest rate changes
Equity REITs (eREITs)
- Own and manage properties such as office buildings, shopping centers, apartments, and warehouses
- Generate revenue from rent collected from tenants
- Used by investors for dividend income while offering more potential for capital appreciation than mortgage REITs
Within equity REITs, these are some of the categories based on the types of properties owned and operated by the REIT. Here are some examples:
Healthcare REITs
- Hospitals
- Medical centers
- Nursing facilities
Commercial REITs
- Shopping malls
- Office buildings
- Data warehouses
Residential REITs
- Multi-family apartments
- Student housing
- Single-family homes
REITs vs. Stocks
REITs
Since a REIT functions as an investment in a real estate company that generates income, they may suit investors who want regular dividend yields.
Stocks
Stocks represent shared ownership of a company, not necessarily related to real estate, and may generally be better suited for investors who want to tap into growth potential.
How do I invest in REITs?
Schwab offers multiple ways to get invested with REITs. Using a Schwab One® Brokerage Account, you can buy shares of an individual REIT, or you can invest in an exchange-traded fund or mutual fund that tracks a broad-based REIT index. Or call us at 888-245-6864 to talk to an experienced specialist about REITs.
Frequently Asked Questions about REITs (Real Estate Investment Trusts)
REITs offer tax advantages by avoiding corporate income tax if they distribute at least 90% of taxable income to shareholders. Investors may benefit from a 20% pass-through deduction on dividends, reducing their effective tax rate. REIT dividends can also include return of capital, deferring taxes. Additionally, REITs can be held in tax-advantaged accounts like IRAs, allowing for tax-deferred or tax-free growth.
While REITs offer diversification and steady income, there are risks. REITs are highly sensitive to interest rate changes, which can impact borrowing costs and share prices. Their performance can also be affected by market volatility and fluctuations in the real estate market as well as changes in occupancy rates. Economic downturns, environmental risks, and shifts in the businesses and industries that lease these properties can all contribute to uncertainty. REIT investors have limited control over management of these challenges.
Publicly traded REITs can be purchased as inexpensively as stocks, you'll just need enough for the cost of the share plus any brokerage commissions and fees. Additionally, there are exchange-traded funds (ETFs) that track a broad-based REIT index. At Schwab, you can buy and sell listed REITs and REIT ETFs online for $0 commission. Private or non-traded REITs often have a minimum investment required.
Yes, but the level of difficulty and potential penalties depend on whether the REIT is publicly traded or not. Shares of publicly traded REITs are generally liquid and can be sold anytime during market hours, just like stocks. Public REITs that aren't traded can be difficult to pull money out of, as issuers often have holding period requirements (e.g., 5-10 years) and may charge early redemption fees. Private REIT withdrawals are even more limited, as the issuer may require you to sell your shares at a discount unless the sale occurs during a predetermined redemption window.