I've owned rental property. I've also owned REITs. After both experiences, I can tell you that REITs are not a perfect substitute for direct real estate ownership, but they're a much better fit for most people's actual goals. The romantic idea of being a landlord—the pride of property ownership, the tangible asset you can see and touch—is seductive, but the reality of dealing with tenants, maintenance, vacancies, and financing is considerably less glamorous.
REITs (Real Estate Investment Trusts) are companies that own portfolios of income-producing real estate. By law, they must distribute at least 90% of their taxable income to shareholders as dividends. This means REITs are typically among the highest-yielding equity investments available. The average REIT yields roughly 4%, compared to about 1.5% for the S&P 500 overall.
How REITs Make Money
REITs generate income through leases on their properties. Office buildings, apartment complexes, retail centers, warehouses, data centers, cell towers—REITs own all of these and collect rent from tenants. The quality of that rent income depends on the occupancy rates, tenant quality, lease terms, and location of the underlying properties.
The second way REITs create value is through property appreciation. If a REIT's management buys properties below intrinsic value, improves them, and benefits from rising real estate values, shareholders capture that appreciation. This is similar to how any business creates value—by buying low and selling high—but with real estate as the underlying asset.
The Different REIT Types
Not all REITs are the same. Equity REITs own and operate properties—they collect rent and manage real estate directly. Mortgage REITs (mREITs) don't own physical property; they finance real estate by holding mortgages and mortgage-backed securities. mREITs use significant leverage and were devastated in 2022-2023 as interest rates rose. Most financial advisors suggest avoiding mREITs unless you deeply understand their risks.
Sector REITs focus on specific property types. Residential REITs (apartments) performed relatively well in the post-pandemic period as housing prices made buying unaffordable for many. Industrial REITs benefited from the e-commerce boom, as distribution centers became critical infrastructure. Healthcare REITs own hospitals, medical offices, and senior housing—defensive assets with stable, government-reimbursed income streams.
The Interest Rate Problem
REITs have a complicated relationship with interest rates. On one hand, rising rates signal economic growth that can support higher occupancies and rents. On the other hand, REIT valuations are partially derived from the present value of future cash flows, and higher discount rates reduce present values. More practically, REITs often carry significant debt, and higher interest rates increase their borrowing costs.
In 2022, as the Federal Reserve raised rates aggressively, REIT prices fell roughly 25%—significantly more than the broader market. This wasn't irrational; higher rates genuinely increase REIT costs and reduce valuations. The lesson is that REIT investors should be prepared for more volatility than the income story alone suggests.
Use our Dividend Analyzer tool to understand the relationship between dividend yield, payout ratio, and dividend sustainability for any REIT you're considering.
When REITs Make Sense in Your Portfolio
REITs offer something most investments don't: inflation-protected income that's often higher than bonds or money market funds. Real estate values and rents tend to rise with inflation, meaning REITs can maintain purchasing power in ways fixed-income instruments cannot. For retirees or near-retirees seeking income, this inflation protection is particularly valuable.
For younger investors with long time horizons, the case for REITs is less clear. Their total return performance has historically lagged growth stocks over 20+ year periods, and the higher dividend yield doesn't compensate for the lower capital appreciation. A total market index fund likely serves most young investors better than a heavy REIT allocation.