REITs as Investment Vehicles

REITs: Own Real Estate Without Owning Property

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Congress created the REIT structure in 1960 to give ordinary investors access to commercial real estate, an asset class that had been available only to the wealthy and institutional capital. The defining feature: a REIT must distribute at least 90% of its taxable income to shareholders as dividends. In exchange, the REIT pays no corporate income tax on distributed earnings. The tax burden passes through to shareholders, avoiding the double taxation that hits regular C-corporations.

Three Types of REITs

REITs fall into three categories based on what they own and how they generate income.

• Equity REITs: Own and operate physical properties. Revenue comes from rent. Examples: Prologis (industrial), AvalonBay (apartments), Simon Property Group (malls). Roughly 90% of all REITs are equity REITs.
• Mortgage REITs (mREITs): Own mortgage-backed securities and real estate loans, not physical property. Revenue comes from the spread between borrowing costs and mortgage yields. Examples: Annaly Capital, AGNC Investment. Higher yields, higher volatility, sensitive to interest rate changes.
• Hybrid REITs: Own both physical properties and mortgages. Relatively rare. Most REITs specialize in one or the other.

Public, Private, and Non-Traded REITs

How a REIT is structured determines your liquidity, transparency, and fee exposure.

• Public REITs: Listed on exchanges (NYSE, NASDAQ). Buy and sell shares like any stock. Transparent pricing, quarterly reporting, high liquidity. Subject to stock market volatility, which can disconnect price from underlying property values.
• Private REITs: Not registered with the SEC. Open only to accredited investors. No public reporting requirements. Illiquid, typically 5-10 year hold periods. Lower volatility because there is no daily market price.
• Non-Traded REITs: Registered with the SEC (so you get disclosure documents) but not listed on an exchange. Historically charged 10-15% in upfront fees and commissions, eating into investor returns before a dollar was deployed. Fee structures have improved in recent years, but read the prospectus carefully.
• Warning: non-traded REITs are sold, not bought. Brokers earn large commissions for placing investors. The incentives are misaligned. If a broker is pushing a non-traded REIT, understand that their 7% commission comes out of your investment.

Public vs. Private vs. Non-Traded REITs

The structure of the REIT determines your experience as an investor.

How to Evaluate a REIT

Traditional earnings metrics do not work for REITs because depreciation distorts net income. Real estate depreciates on paper but often appreciates in reality. REIT-specific metrics strip out depreciation to show the true cash-generating power of the portfolio.

• FFO (Funds From Operations): Net income + depreciation/amortization - gains on property sales. The standard REIT earnings metric. Published by every public REIT.
• AFFO (Adjusted FFO): FFO minus recurring capital expenditures (roof repairs, HVAC replacements, tenant improvements). More conservative and closer to true distributable cash flow.
• NAV (Net Asset Value): Market value of all properties minus total liabilities. Tells you what the REIT's assets are worth if liquidated. Compare to share price to see if you are buying at a premium or discount.
• Dividend Yield: Annual dividend divided by share price. REIT yields typically range from 3-7%. Yields above 8-10% may signal the market expects a dividend cut.
• Payout Ratio: Dividends as a percentage of FFO. Below 75% is conservative. Above 90% leaves little margin for property downturns or capital expenditures.

REIT Pitfalls

REITs trade at market-driven prices that can diverge significantly from the underlying property values. During the 2020 COVID sell-off, public REIT prices dropped 30-40% in weeks while the actual real estate barely changed. You can be right about the real estate and wrong about the timing. Mortgage REITs are particularly volatile because they use leverage to amplify the spread between borrowing and lending rates. When rates move against them, mREITs can lose 20-50% in months. Non-traded REITs deserve special scrutiny. The high fee loads (5-15% historically) mean your investment starts in a hole. A non-traded REIT must outperform a public REIT by the fee differential just to break even.

REITs let you invest in institutional real estate without buying property. Public REITs offer liquidity but carry stock market volatility. Private REITs offer stability but lock up capital. Non-traded REITs have historically carried excessive fees. Use FFO, AFFO, and NAV as your evaluation metrics. The 90% distribution requirement makes REITs a strong income vehicle, but choose the structure that matches your liquidity needs and fee tolerance.