What it means
The structure exists to remove double taxation. Ordinarily a property company pays corporate tax on its profits and shareholders pay tax again on dividends, whereas a REIT that distributes at least 90% of its taxable income is largely exempt at the company level, leaving the tax to be paid by the shareholder.
Rules also require most assets and income to come from property. REITs matter because they turned an illiquid asset into something anyone can buy before lunch.
An investor with $2,000 can own a fraction of hundreds of warehouses or shopping malls, receive quarterly income, and sell the position instantly on an exchange. That access is the main reason REITs have become a standard portfolio building block.
The measure analysts use is not earnings per share but funds from operations (FFO), which adds depreciation back to net income and strips out gains on property sales. Depreciation assumes buildings steadily lose value, yet well-maintained property often does the opposite, so accounting profit badly understates the cash a REIT actually generates.
Comparing price to FFO plays the same role that the price-to-earnings ratio plays for ordinary companies. The category splits several ways.
Equity REITs own buildings and collect rent, mortgage REITs lend against property and collect interest, and within equity REITs there are specialists in offices, industrial space, data storage, healthcare, self-storage and homes. Some REITs are listed and trade freely, while non-traded versions offer little liquidity and often carry higher fees.
The main risk is that REITs are sensitive to interest rates on two fronts. Higher rates raise their own borrowing costs and simultaneously make the dividend look less attractive against bonds, which is why REIT prices often fall when rates rise even if rents are still growing.
In practice
Real-world examples.
Example
A retired teacher wants property income without tenants or repairs, so she puts $60,000 into a diversified REIT paying a 4.5% yield. She receives roughly $2,700 a year in dividends and can sell the holding in a single trade if she needs the cash.
Example
A corporate pension fund needs long-dated income to match its liabilities and buys a healthcare REIT that owns hospitals let on 20-year leases. The leases include annual increases tied to inflation, which suits the fund's obligations.
Example
A logistics operator sells its warehouse portfolio to a REIT for $340,000,000 and leases the buildings back. The operator frees capital for its core business while the REIT gains a long lease with a known tenant.
Think of it
“Real estate investment trust is a company that owns real estate and passes income to shareholders.
Formula
Calculation
FFO = Net income + Depreciation and amortisation - Gains on property sales. FFO per share = FFO / Shares outstanding.
An industrial REIT reports net income of $42,000,000 for the year. Depreciation and amortisation charged against its buildings came to $58,000,000, and it booked a $10,000,000 gain on selling one older estate.
FFO = $42,000,000 + $58,000,000 - $10,000,000 = $90,000,000.
The REIT has 60,000,000 shares in issue, so FFO per share = $90,000,000 / 60,000,000 = $1.50. Earnings per share, by contrast, is only $42,000,000 / 60,000,000 = $0.70.
The shares trade at $24.00, giving a price-to-FFO multiple of $24.00 / $1.50 = 16.0. The annual dividend is $1.20 per share, so the yield is $1.20 / $24.00 = 5%, and the payout consumes $1.20 / $1.50 = 80% of FFO. Judged on earnings alone the dividend would look impossible, since $1.20 exceeds $0.70, which is exactly why FFO is the measure that gets used.Case study
Seen in the real world.
Beacon Yard Trust is an illustrative, fictional REIT used here to show how the payout rule shapes behaviour. In its early years the trust owned 22 suburban office buildings and distributed 92% of taxable income every year, which pleased income investors and kept its tax bill near zero.
The problem in the fictional scenario appeared when several tenants shrank their space and Beacon Yard needed roughly $70,000,000 to convert three buildings into laboratory and light industrial use. Because almost all cash had been distributed, the trust had nothing retained to fund the work and had to choose between issuing new shares, borrowing at a higher rate, or selling assets into a weak market.
The illustrative point is that the tax advantage of a REIT comes with a permanent constraint: a business that must pay out its profit cannot self-fund reinvestment. Beacon Yard eventually issued shares at a discount, diluting existing holders, and its board added a policy of selling one non-core asset each year to build a modest repair reserve.
Watch out
Common mistakes.
- Comparing REITs on the price-to-earnings ratio. Depreciation distorts REIT earnings so heavily that the ratio is close to meaningless; use price to funds from operations instead.
- Chasing the highest dividend yield. An unusually high yield often signals that the market expects the dividend to be cut or that the portfolio carries too much debt.
- Assuming REITs behave like the housing market. Most large REITs own commercial, industrial or specialist property, and their prices often move with interest rates and equity markets instead.
Questions
People also ask.
Do REITs have to distribute 90% of profit?
In most jurisdictions the rule is set around that level for taxable income, and failing the test costs the trust its tax-advantaged status.
Are REIT dividends taxed differently?
Often yes, because the income has not been taxed at the company level, so it can be treated as ordinary income for the investor rather than as a qualifying dividend.
Can a REIT lose money for investors?
Certainly, since share prices fall when property values, occupancy or investor appetite decline, and heavily indebted REITs have cut dividends in past downturns.
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