A guide to real estate investment trusts (REITs): how they work and how to invest

Written by Samantha SheltonNMLS 1647301Updated October 2026

This is general education, not tax advice, and not investment advice or a solicitation to buy or sell any security. Align Lending is an independent Michigan mortgage broker, not a broker-dealer, investment adviser, or securities issuer. Take tax questions to a CPA and portfolio questions to a licensed investment professional.

Midwestern downtown skyline with apartment, office and industrial buildings representing the property sectors REITs own

A real estate investment trust is a company that owns, operates or finances income-producing real estate and passes nearly all of its profit to shareholders. The payout is a condition of the tax status, not a preference: a REIT must distribute at least 90% of its taxable income as dividends, hold at least 75% of its assets in real estate, cash and government securities, and draw at least 75% of gross income from real estate sources.

Because a REIT deducts what it distributes, its income is generally taxed once, in your hands, mostly as ordinary income rather than at qualified-dividend rates. That is why yields sit above the broad market: the FTSE Nareit All Equity REITs index yielded 3.56% in July 2026 against 1.03% for the S&P 500, per Nareit. Past performance never predicts future results.

Learn how a company qualifies, how equity and mortgage REITs earn money, how dividends are taxed, and where a REIT fits against owning a rental. New to the category? Start with our Real Estate Investing guide and the investing basics hub.

Key takeaways:

The 90% rule explains the yield: A REIT must pay out at least 90% of taxable income as dividends to keep its status, so a high payout is a licensing condition, not a sign of strength.
Equity REITs dominate: They held $1.59 trillion of the $1.66 trillion FTSE Nareit All REITs equity market capitalization in July 2026, leaving mortgage REITs (which finance real estate rather than own it, and are far more rate-sensitive) at about 4% of the total.
Ordinary income is the default: By market-cap-weighted average, 79% of 2025 REIT dividends were ordinary taxable income, 10% return of capital and 11% long-term capital gain, which is why many investors hold REITs inside an IRA or 401(k).

What is a real estate investment trust (REIT)?

A REIT is a company that owns, operates or finances income-producing real estate and elects to be taxed under a part of the Internal Revenue Code that lets it deduct the dividends it pays. Congress created the structure on September 14, 1960, in Public Law 86-779, so people of modest means could own a share of portfolios that had been the preserve of institutions.

The industry it built is large. As of July 31, 2026, 183 REITs sat in the FTSE Nareit All REITs Index with $1.66 trillion of equity market capitalization, 149 traded on the New York Stock Exchange, and REITs owned more than $4.5 trillion of U.S. commercial real estate, per Nareit. Listed REITs paid roughly $71 billion in dividends during 2025; non-listed REITs paid about $5 billion.

The appeal is exposure to apartments, warehouses, data centers and cell towers without a down payment, a closing, or a tenant, a different proposition from the benefits of investing in real estate directly. The SEC’s overview of REITs is a good starting reference.

What tests must a company pass to qualify as a REIT?

Six, and failing any can cost the company its status. The distribution rule gets the attention, but the asset and income tests keep a REIT from drifting into an ordinary operating company.

Test	The rule	What it means for you
Distribution	Dividends paid must equal at least 90% of REIT taxable income, computed without the dividends-paid deduction and excluding net capital gain.	Little cash is retained, so REITs fund growth by issuing shares or borrowing.
Asset test	At the close of each quarter, at least 75% of total asset value must be real estate assets, cash and cash items, and government securities.	You are buying a real estate company, not a conglomerate.
75% income test	At least 75% of gross income must come from rents, interest on obligations secured by mortgages on real property, and similar sources.	Earnings track occupancy, rents and loan interest.
95% income test	At least 95% must come from those sources plus dividends, interest, and gains from sales of stock and securities.	Only a thin slice can come from anything else.
Ownership	Shares must be held by 100 or more persons for at least 335 days of a 12-month taxable year.	A REIT cannot be a closed circle of a few investors.
Not closely held	Five or fewer individuals may not own more than 50% of share value during the last half of the taxable year, the “5/50” rule.	Control is dispersed by law.

A second rule pushes the same way: a 4% excise tax applies to the shortfall if a REIT distributes less than 85% of its ordinary income plus 95% of its capital gain net income for the calendar year. Between them, most REITs pay out close to everything.

The ownership and 5/50 tests also explain why REITs are more accessible than private deals: a structure legally required to have 100 owners is built for retail participation, unlike a real estate syndication sold to a small group.

How do equity, mortgage and hybrid REITs make money?

Equity REITs collect rent; mortgage REITs collect an interest spread. That one difference drives nearly everything else, and it is what new investors miss most often.

Feature	Equity REIT	Mortgage REIT (mREIT)	Hybrid
What it holds	Apartments, industrial, retail, offices, data centers, towers	Mortgages and mortgage-backed securities	A mix of both
Income source	Rent, plus gains on sale	The spread between borrowing costs and interest received	Rent and interest
Main risk driver	Occupancy, rent growth and property values	Rate moves, prepayments and the cost of leverage	Both, in proportion
Share of listed market	$1.59 trillion of $1.66 trillion, July 2026	The roughly $70 billion remainder, about 4%	Counted within the two above

Mortgage REITs are the more volatile because they are leveraged bond portfolios in a real estate wrapper. When short-term borrowing costs rise faster than the yield on the mortgages they hold, the spread compresses and the dividend follows. If your real interest is financing your own property, that is a lending conversation, see how to refinance an investment property.

Equity REITs are organized by property sector, and the sectors answer to different demand cycles, one reason REITs come up in discussions of real estate market diversification. Concentration inside a single REIT is still a real risk, and correlation with the broader stock market runs higher than investors expect.

Publicly traded, non-traded or private: which REITs can you actually sell?

Liquidity is the sharpest dividing line, and where the most money gets lost. A listed REIT sells in seconds; a non-traded REIT may offer no real exit for more than 10 years.¹

Feature	Publicly traded REIT	Public non-traded REIT	Private REIT
How you buy	Any brokerage account, like a stock	Through a broker or adviser, at a set offering price	Private offering, generally to accredited investors
Liquidity	Daily exchange trading; settles one business day after the trade	Limited redemption programs; can be capped, discounted or discontinued without notice	Least liquid; exit terms set by the sponsor’s documents
Upfront costs	Ordinary brokerage commissions, often zero	Commissions and offering fees typically 9% to 10% of the investment, up to 15% of the offering price	Varies; disclosure is not standardized
Valuation	A live market price	Periodic estimated per-share value based on appraisals	Sponsor-determined
SEC reporting	Registered; files 10-K and 10-Q	Registered; files 10-K and 10-Q	Not registered; generally files neither

The SEC’s bulletin on non-traded REITs is blunt about three risks. Redemption programs are typically subject to significant limitations and may be discontinued at the REIT’s discretion. Non-traded REITs may use offering proceeds, your money, and borrowings to pay distributions, which reduces share value. And external managers earning transaction and management fees may have interests that diverge from yours.

Private REITs sit further out. They are generally sold only to accredited investors, a status resting on net worth above $1 million excluding your primary residence, or income above $200,000 individually or $300,000 with a spouse in each of the two most recent years with a reasonable expectation of the same this year. Certain professional certifications also qualify. The same gate governs much of real estate crowdfunding.

How are REIT dividends taxed?

Mostly as ordinary income. The SEC states plainly that REIT dividends generally are treated as ordinary income and are not entitled to the reduced rates on other corporate dividends.² That is the most misunderstood fact about REITs, and the reason the account you hold them in matters as much as the REIT you pick. A distribution usually arrives in three pieces, split out on your Form 1099-DIV.

Ordinary dividends: Taxed at your marginal rate. By market-cap-weighted average, 79% of 2025 REIT dividends fell here, per Nareit.
Capital gain distributions: Taxed at capital gains rates, 11% of 2025 dividends. Any portion designated as unrecaptured Section 1250 gain, which comes from depreciation on the buildings, is taxed at a maximum 25% rate.
Return of capital: 10% of 2025 dividends. Not taxed on receipt; it reduces your cost basis, so it resurfaces as a larger capital gain at sale. Once basis hits zero, further nondividend distributions are taxable gain.

The ordinary slice gets one break. The Section 199A deduction allows up to 20% of qualified REIT dividends to be deducted, and unlike the main business component it is not limited by W-2 wages or the unadjusted basis of qualified property. You must have held the shares more than 45 days, and an overall limit tied to your taxable income applies. The 2025 reconciliation law made the deduction permanent for tax years beginning after December 31, 2025.

On real money: say you hold $25,000 in a broad REIT index yielding 3.56%, split the way 2025 dividends were.³ You receive about $890, roughly $703 ordinary, $98 long-term capital gain and $89 return of capital. At a 24% marginal rate the ordinary slice would cost about $169; the 20% deduction trims the taxable portion to about $562 and the tax to about $135. The $89 return of capital lowers your basis and is settled later.

An IRA or 401(k) sidesteps the ordinary-income problem, which is why advisers commonly place REITs there. And REIT shares are stock, so the real property tax machinery does not apply: no depreciation deduction, no 1031 exchange out of the position, and none of the capital gains tax exemptions that attach to a primary residence.

How do you judge whether a REIT’s yield is real?

Use funds from operations, not net income. Nareit created FFO in 1991 because real estate depreciation is a large non-cash charge that makes a profitable REIT look unprofitable under GAAP. FFO is GAAP net income, excluding gains and losses from property sales and debt restructuring, plus real estate depreciation and amortization, after adjustments for unconsolidated partnerships and joint ventures.

Compare the dividend to FFO: A payout ratio above 100% of FFO means the distribution is funded by something other than operations.
Read the occupancy trend: Rent drives everything for an equity REIT, and falling occupancy hits the dividend before the price.
Check the debt maturity schedule: REITs retain almost no cash, so a wall of maturities in a high-rate year is a dividend risk.
Treat a very high yield as a question: Yield rises when price falls, so a double-digit number usually means the market expects a cut.

All of it is free on EDGAR in a REIT’s 10-K and 10-Q, an advantage listed REITs hold over private deals. Still mapping out an approach? See how to become a real estate investor.

Where does a REIT fit against owning property directly?

A REIT buys exposure and liquidity; direct ownership buys control and leverage. Plenty of investors hold both.

Leverage: You cannot mortgage a REIT share. You can finance a rental: Fannie Mae’s Eligibility Matrix caps a fixed-rate one-unit investment property purchase at 85% loan-to-value, so at least 15% down, and an adjustable-rate one at 75%. Leverage magnifies losses as readily as gains.
Tax treatment: Direct owners depreciate residential rental buildings over 27.5 years and deduct operating expenses. REIT shareholders get neither, because depreciation happens inside the REIT.
Liquidity: Listed REIT shares settle one business day after the trade, a standard the SEC shortened on May 28, 2024. Selling a rental takes months.
Control: You pick the tenants, rent and renovations on a property you own. In a REIT, management decides and you hold a vote.
Concentration: One rental is one building on one street; a REIT fund holds hundreds.

Align Lending is a mortgage broker, so our lane is the financing side: buying a second home, refinancing a multi-family home, or a portfolio loan when agency guidelines do not fit. We do not sell securities and we do not recommend REITs.

How Align finances investors

Samantha looks at the property's numbers before the loan's, and she says so plainly: "I don't love a deal that only works when nothing goes wrong."

Align places DSCR loans, which qualify on the rent the property brings in rather than your tax returns, as well as conventional investment loans, through multiple wholesale lenders.

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FAQ: Real estate investment trusts

Here are answers to common questions about REITs.

How much money do you need to start investing in REITs?

Very little. Publicly traded REITs and REIT funds trade like stocks through any brokerage account, and brokers offering fractional shares let you start with a few dollars. Non-traded and private REITs are a different product: higher upfront fees, investment minimums, and no daily liquidity. Our investing basics hub covers account setup and terminology.

Are REIT dividends safe?

No dividend is guaranteed. Because a REIT must distribute at least 90% of taxable income, its dividend tracks property performance closely and gets cut when occupancy or rents fall or refinancing turns expensive. Judge sustainability by funds from operations, not net income, and check the payout ratio against FFO, occupancy and the debt maturity schedule. Compare the risk with the benefits of investing in real estate.

What is the difference between an equity REIT and a mortgage REIT?

Equity REITs own property and earn from rent and appreciation, so their risk tracks occupancy, rents and values. Mortgage REITs own mortgages and mortgage-backed securities and earn the spread between borrowing costs and interest received, making them far more rate-sensitive and typically more volatile. Equity REITs held $1.59 trillion of the $1.66 trillion listed market in July 2026.

How are REITs taxed?

Most REIT dividends are taxed as ordinary income rather than at the lower qualified-dividend rate, though up to 20% may be deductible under Section 199A if you held the shares more than 45 days. Capital gain distributions are taxed at capital gains rates, with any unrecaptured Section 1250 portion capped at 25%, and return-of-capital amounts reduce your basis instead of being taxed now. Compare the tax benefits of real estate investing, and confirm your situation with a tax professional.

The bottom line on REITs

A REIT must distribute at least 90% of its taxable income, hold at least 75% of its assets in real estate, and draw at least 75% of gross income from real estate sources. Those tests are why the yield is high and why most of it lands on your return as ordinary income, 79% of 2025 REIT dividends by market-cap-weighted average. Equity REITs own buildings and follow rents; mortgage REITs own loans and follow rates. Listed REITs sell in a day; non-traded REITs often do not sell for a decade.

If you would rather own the building than a share of it, talk to Align Lending. We’ll shop your investment property financing across our lender network and show you the pricing side by side. Call 248-506-5727 or start online. Take tax questions to a CPA, securities questions to a licensed investment professional, and legal questions to a Michigan attorney.

Footnotes:

1. This article is for informational purposes only and is not investment advice, a recommendation, an offer, or a solicitation to buy or sell any security. Align Lending is an independent Michigan mortgage broker, NMLS #2041154, and is not a broker-dealer, investment adviser, or securities issuer. REIT structures, fees, redemption terms and liquidity vary by issuer and are described in each issuer’s offering documents; investments in REITs can lose value. Return to text.

2. This is general information, not tax advice. REIT dividend characterization, eligibility for the Section 199A deduction, holding-period requirements, basis adjustments and the treatment of capital gain distributions depend on your individual circumstances, and tax law changes. Consult a qualified tax professional about your situation. Return to text.

3. Example figures are hypothetical and for educational purposes only; they do not constitute an advertisement of credit terms, a rate quote, or a projection of investment returns. The $25,000 position, the 3.56% index yield, the 79%/11%/10% dividend split, and the 24% marginal rate are Align Lending illustrations shown to demonstrate how the components of a REIT distribution are taxed. They ignore state and local tax, the 3.8% net investment income tax, brokerage costs, and any overall taxable-income limitation on the Section 199A deduction. Actual results depend on the securities held, their distributions, and your return. Past performance does not predict future results. Return to text.

Sources: requirement that the deduction for dividends paid equal at least 90% of REIT taxable income, computed without the dividends-paid deduction and excluding net capital gain, Internal Revenue Code section 857(a)(1) and IRS Instructions for Form 1120-REIT. Requirement that a REIT be managed by one or more trustees or directors, have transferable shares, be held by 100 or more persons for at least 335 days of a 12-month taxable year, and not be closely held under the five-or-fewer-individuals/more-than-50%-of-value test applied during the last half of the taxable year, 26 U.S.C. 856(a), 856(b) and 856(h). Requirement that at least 75% of the value of total assets at the close of each quarter be real estate assets, cash and cash items, and Government securities, 26 U.S.C. 856(c)(4)(A). Requirement that at least 75% of gross income derive from real property sources and at least 95% from those sources plus dividends, interest and securities gains, 26 U.S.C. 856(c)(2) and 856(c)(3). Four percent excise tax on the excess of the required distribution, 85% of ordinary income plus 95% of capital gain net income for the calendar year, over the distributed amount, 26 U.S.C. 4981 and IRS Form 8612. Enactment of the REIT provisions in Public Law 86-779, signed September 14, 1960. Statement that dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends, and that sales commissions and upfront offering fees on non-traded REITs usually total approximately 9 to 10 percent of the investment, U.S. Securities and Exchange Commission, Investor.gov, Real Estate Investment Trusts (REITs). Non-traded REIT illiquidity, waits that may exceed 10 years, redemption programs subject to significant limitations that may be discontinued at the REIT’s discretion or require redemption at a discount, upfront fees and commissions representing up to 15 percent of the offering price, use of offering proceeds and borrowings to pay distributions, external-manager conflicts of interest, valuation based on periodic appraisals, and Form 10-K and 10-Q reporting by SEC-registered non-traded REITs, SEC Office of Investor Education and Advocacy, Investor Bulletin: Non-traded REITs. Accredited investor standards of net worth exceeding $1 million excluding the value of the primary residence, or income exceeding $200,000 individually or $300,000 jointly with a spouse or spousal equivalent in each of the two most recent years with a reasonable expectation of the same in the current year, plus certain professional certifications, 17 CFR 230.501(a) and SEC Investor Bulletin: Accredited Investors. Shortening of the standard settlement cycle to one business day after the trade date effective May 28, 2024, U.S. Securities and Exchange Commission. Deduction of up to 20% of qualified REIT dividends, the exclusion of that component from the W-2 wage and unadjusted-basis limitations, and the more-than-45-day holding period, Internal Revenue Service, Qualified Business Income Deduction and Instructions for Form 8995 (2025). Permanence of the section 199A deduction for tax years beginning after December 31, 2025, section 70105 of P.L. 119-21, as described in Congressional Research Service Report R48611. Reporting of ordinary dividends, capital gain distributions and nondividend distributions that reduce basis, IRS Instructions for Form 1099-DIV and IRS Topic No. 404. Maximum 25% rate on unrecaptured section 1250 gain, IRS Topic No. 409 and Publication 550. Limitation of like-kind exchanges to real property, and the 45-day identification and 180-day exchange periods, 26 U.S.C. 1031. Maximum 85% loan-to-value on a fixed-rate one-unit investment property purchase and 75% on an adjustable-rate one, Fannie Mae Eligibility Matrix. FTSE Nareit All REITs equity market capitalization of $1.66 trillion, FTSE Nareit All Equity REITs equity market capitalization of $1.59 trillion, 183 REITs in the FTSE Nareit All REITs Index, 149 REITs trading on the New York Stock Exchange, more than $4.5 trillion of commercial real estate assets owned, FTSE Nareit All Equity REITs dividend yield of 3.56% and All REITs dividend yield of 3.93% against 1.03% for the S&P 500, all as of July 31, 2026; approximately $71 billion in dividends paid by public listed REITs and $5 billion by public non-listed REITs during 2025; and a market-cap-weighted dividend composition of 79% ordinary taxable income, 10% return of capital and 11% long-term capital gains in 2025, Nareit REIT Industry Financial Snapshot. Definition of funds from operations as GAAP net income excluding gains and losses from sales of property and debt restructuring, plus real estate depreciation and amortization, after adjustments for unconsolidated partnerships and joint ventures, and its creation in 1991, Nareit. The statement that mortgage REITs represent roughly $70 billion, or about 4%, of listed REIT equity market capitalization is an Align Lending calculation from the two Nareit market-capitalization figures cited above.

This article is for informational purposes only and is not intended to provide legal, financial, investment, or tax advice, and is not a recommendation, offer, or solicitation to buy or sell any security. Tax rules, securities regulations, market data and loan program requirements change and vary by program, property, and locality; confirm tax treatment with a qualified tax professional, securities questions with a licensed investment professional, legal and entity questions with a Michigan attorney, and current financing figures with your loan officer. Figures shown are illustrative, are not a rate quote or an offer of credit, and do not constitute an advertisement of credit terms. Past performance does not predict future results. Align Lending is an independent Michigan mortgage broker, NMLS #2041154, and is not a broker-dealer, investment adviser, or securities issuer.