What is a real estate investment trust (REIT)?

Investors buy shares of a REIT and in turn, the REIT investment fund manager uses that capital to make investments on behalf of its investors. A REIT typically earns income from rental payments on equity investments and from interest payments on debt investments.

REITs were invented in the United States under the Cigar Excise Tax Extension of 1960 to give investors of all sizes a way to invest in diversified portfolios of cash-flowing commercial real estate. REITs enable investors to access real estate investment similar to the way that stocks provide an opportunity to participate in the profits of an operating company. REIT investments allow investors to earn money from the income produced by real properties without requiring investors to own properties directly or contribute to the investment in any way other than the purchase of their shares.

A REIT is a unique company structure because it must follow a specific set of operating requirements. For example, a REIT is required to derive at least 75% of gross income from real estate-related sources and it must also invest at least 75% of its total assets in real estate. Additionally, a REIT must distribute at least 90% of its taxable income every year to shareholders through dividend distributions. If a REIT meets the qualifications, then it’s not required to pay taxes at the company level. This removes the double taxation that investors often encounter when investing in traditional company stocks. Instead, investors only pay income taxes for the dividends they receive at the investor level, which enables investors to keep a larger portion of that income stream and earn higher returns.

Additionally, the Tax Cuts and Jobs Act of 2017 introduced a tax deduction of up to 20% for investors who receive income distributions from pass-through entities, which most REITs are. Specifically, investors can access up to a 20% tax deduction on qualified business income that they receive annually from pass-through businesses, such as REITs.

There are many types of REITs. They are categorized by the way investors can access them (publicly traded, public non-traded, private), the way they invest in assets (equity or debt), the type of assets they own (apartments, data centers, self-storage, hospitals, office, etc.), and their overall investment strategy (core, value-add, opportunistic).