What are REITs?

Real estate investment trusts, or REITs, are special purpose entities with a special tax status that own real estate and pass along most of the income from that real estate (rents or mortgage payments) to shareholders.

That’s a mouthful! So in real life, what are REITs? A real estate investment trust can own any type of real estate, though many specialize in one kind, like apartment buildings, malls, office buildings, self-storage facilities, or hotels. Others may focus on a particular industry, like clean energy or medical facilities. In that sense, they can act very much like an ETF or Mutual Fund.

There are two types of REITs. An equity REIT owns property directly and gets most of its income from its tenants’ rents. A mortgage REIT does not own property directly. Instead, it owns property mortgages and mortgage-backed securities. Its revenue comes from the interest it’s paid on the mortgages.

Like any investment, a real estate investment trust has pros and cons. As a rule, REITs pay dividends. (They’re required by law to pass 90% of their taxable income through to shareholders.) Some of them even pay out monthly, and the yields can be high. They tend to be conservative investments, and you can buy and sell them much the same way as you would any other stock or ETF. They’re also a great way to diversify an existing stock portfolio.

On the negative side of things, because most of the income gets distributed to shareholders, there isn’t much left over for growth. So you may not see the skyrocketing numbers of, say, a hot tech stock.

It’s also worth mentioning that about 70% of those distributions are taxable as ordinary income. This can be an excellent reason to own REITs in a tax-advantaged account like an IRA.

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