REITs: How Do They Work

REITs: How Do They Work

Investing in real estate typically involves directly owning property, which demands substantial capital and comes with liquidity challenges. To address these limitations, the concept of Real Estate Investment Trusts (REITs) was introduced in the United States in 1960. Real Estate Investment Trust (REIT) is a financial instrument that allows investors to gain exposure to real estate without having to buy or manage physical properties themselves.  REITs are companies that own, operate, and manage real estate, spanning various industries such as residential apartments, commercial properties like offices and retail stores, or even healthcare facilities.

Why Were They Created?
Traditionally, only wealthy individuals or large corporations can afford income-generating real estate properties. REITs changed the landscape by creating a system where many small investors could pool their funds and collectively invest in large-scale real estate projects. ⁽¹⁾

REITs have gained popularity in the global world, offering investors diversification, liquidity, and passive income.

Types of Real Estate Investment Trusts (REITs)
There are different kinds of REITs, each catering to specific investment strategies and risk appetites. Some of them are categorized by investment type, and are based on whether they own properties, finance them, or both. Some REITs based on investment type are-

1.     Equity REITs – Equity REITs are firms that invest and operate revenue-generating properties, like office buildings. By purchasing their shares, investors have an opportunity to earn dividends, often derived from rental income. These REITs are also required to give at least 90% of their taxable income to shareholders. ⁽²⁾

2.     Mortgage REITs – Mortgage REITs provide funding for real estate mainly through buying or originating mortgages and mortgage-backed securities. So, instead of owning properties, they earn income from interest on these loans. Like equity REITs, they also must distribute 90% of their taxable income to shareholders.⁽³⁾

3.     Hybrid REITs- Some REITs want to diversify their portfolio by owning rental properties as well as investing in mortgage-backed securities. Depending upon the interest, they may choose to incline their investment towards properties or loans, so it's important to check their strategies and portfolio. ⁽⁴⁾ REITs are also based on trading status. They include publicly traded, publicly non-traded, or private REITs based on different levels of access, transparency, and liquidity.

4.     Publicly Traded REITs- Publicly traded REITs are registered with the SEC and listed on stock exchanges, allowing investors to buy and sell shares like stocks. ⁽⁵⁾

5.     Publicly non-traded REITs- They act similarly to publicly traded REITs, in which REITs earn from rental income and receive steady dividends, but selling your shares is complex. These are registered with the SEC but not listed on the stock exchanges. Thus, they offer high dividends as compared to publicly traded REITs but provide less liquidity as buying and selling is a complex process. ⁽⁵⁾

6.     Private REITs- A private REIT owns ultra-luxury villas at exotic locations and only rents them to high-profile clients or celebrities. Investors' main income is premium rentals received, but the drawback is that they must commit to long-term investments. Private REITs are not registered with the SEC and do not trade on stock exchanges. They are also typically available only to high institutional investors or individuals with high net worth. ⁽⁵⁾

Thus, each REIT has its unique features and caters to different investment goals. From steady income to preferring only high institutional investors, REITs provide a diverse and accessible way to invest in real estate.

How REITs Work: Turning Investments into Real Estate Wealth
Real Estate Investment Trusts (REITs) act like a bridge between individual investors and large-scale real estate ventures. Instead of buying a property individually, many investors come together and put their funds together and form a REIT, which then acquires and manages income-generating assets like shopping complexes, residential apartments, or warehouses.

To understand, REIT functions similarly to mutual funds, bringing together capital from multiple investors to create a diversified portfolio of real estate assets. The person who sets up the trust is known as the sponsor. The sponsor then raises the funds, which are used further to purchase and maintain high-quality commercial properties, ensuring steady rental income. ⁽⁶⁾

How do Investors earn?
Investors benefit from 2 primary ways-

1.     Dividends from rental income- REITs are legally required to distribute at least 90% of taxable income to shareholders in the form of dividends. This helps investors earn steady income, making it a compelling choice. ⁽⁷⁾

2.     Capital Appreciation- Over time, the value of the properties owned by REIT may increase, leading to higher share prices. Investors can then sell their shares, thus benefiting from long-term capital appreciation. ⁽⁵⁾

Why REITs Are a Smart Investment Choice
REITs are now known for providing steady passive income, diversification, and liquidity to their investors. All this without the hassle of direct property ownership. Here’s why they are considered a smart investment choice-

1.     Consistent passive income
One of the biggest advantages of REIT, which makes it preferable, is its high dividend payout. REITs are legally required to pay 90% of their taxable income to shareholders, making them a trustworthy source for steady income. For example, Federal Realty Investment Trust announced an annual dividend increase of 2.83% in 2024, marking its 57th consecutive dividend increase —the longest in the REIT industry. ⁽⁸⁾ As there is no age limit in REITs, this makes it popular among retirees and income-focused investors too.  According to an article by The Motley Fool, “ most REITs pay out more than 90% of their taxable income because their cash flows, as measured by funds from operations (FFO), are often much higher than net income since REITs tend to record large amounts of depreciation each year.”⁽⁸⁾

2.     Portfolio Diversification
REITs allow investors to diversify their real estate portfolios by making different real estate investments, like shopping malls, residential buildings, or even healthcare facilities like hospitals. Since not all REITs are affected by the stock market, investing in them can reduce investors' overall portfolio risks. ⁽⁹⁾ According to an investment advisor, “Diversification through REITs reduces the risk of relying on a single property or market.” ⁽⁴⁾

3.     Liquidity and Accessibility
Traditionally, real estate required large capital and long holding periods. But now publicly traded REITs can be bought and sold like stocks. This provides investors with flexibility in utilizing their funds whenever needed. ⁽⁴⁾ For example, Mindspace Business Parks REIT is listed on the stock exchange, and investors can trade their shares like stocks. This provides them with liquidity and a feasible way to trade their shares. ⁽¹⁰⁾

4.     Inflation and Potential Growth
As urbanization increases, demand for property also increases, appreciating the value of REIT. Additionally, REITs' values also increase with inflation. One significant example of it is Brookfield India Real Estate Trust, “The trust demonstrates exceptional financial performance with a cash flow margin of 77.26%, underscoring operational efficiency. Moreover, it is poised for a remarkable turnaround, with an expected earnings growth of 610.51% next year, a significant improvement from its three-year CAGR earnings decline of -9.98%.” ⁽¹⁰⁾

5.     Professionally Managed
In REITs, usually experienced professionals, who are already into property acquisition, leasing, and maintenance, invest. This reduced the burden on investors of engaging directly with tenants and ensured optimal returns.

REITs offer a low barrier to entry into real estate investment, making them an excellent choice for beginners and seasoned investors.

Limitations of Investing in REITs
Understanding limitations associated with REITs can help investors in making informed decisions.

·       Market Volatility- Unlike direct real estate investments, REITs, which are publicly traded, i.e., listed on stock exchanges, fluctuate based on the market conditions. During the COVID-19 pandemic, as the infrastructure development went on hold, many REITs related to commercial construction saw their share prices plummet due to reduced demand. Investors who relied on such REITs faced sudden losses. Thus, economic downturns, interest rate hikes, and investor sentiments can bring price swings in REITs. ⁽¹¹⁾

·       Interest Rate Sensitivity- REITs often rely on debt financing for acquiring and managing properties. When the interest rate rises, borrowing costs increase, and this reduces profit margins and dividend payouts. For example, if the Central bank raises interest rates, then mortgage REITs may struggle as borrowing costs will increase. This will impact their ability to finance new projects profitably. ⁽¹²⁾

·       Regular Tax Implications- Do you know, according to an article by tax guru, “If units are held for longer than three years (36 months) and generate income of more than Rs. one lakh, they will be subject to 10% LTCG tax.” So, REITs must comply with strict regulations, including mandatory dividend payouts and other tax rules. ⁽¹³⁾

While REITs provide easy access to real estate investing, they do come with risks. Market dynamics, interest rate sensitivity, and tax implications can affect returns. Therefore, investors should exercise caution when assessing these risks.  

How to Invest in REITs
Whether you are a retail investor or an accredited investor, there is always an option for you. But most people don’t know how to invest in REITs, let’s look at some of the options-

·       Buying publicly traded REITs on stock exchanges
Publicly traded REITs are listed on stock exchanges, allowing investors to buy and sell shares just like stocks. This brings high liquidity, transparency, and ease of access. Investors can also buy and sell at their convenience.

·       Investing in Private REITs for Accredited Investors
Private REITs are not listed on stock exchanges and are available only to institutional investors or individuals with high net worth. They require higher investments and provide higher returns.

·       REIT mutual funds
Investors who prefer diversification REIT mutual funds provide exposure to multiple REITs. An investor can buy a REIT mutual fund that includes office, retail, and industrial REITs, ensuring a balanced portfolio.

Real Estate Investment Trust Vs. Real Estate Operating Company
So, you want to invest in real estate, but you’re confused between REIT and REOC? Let’s understand the key differences between the two-

REIT is like a dependable person who always sends you money when they make a profit, out of your investment. REITs are mandated by law to distribute 90% of their taxable income to investors, which means investors get regular dividends. REOC, on the other hand, are like money-minded entrepreneurs, who instead of paying out profits, reinvest the earnings into new projects. Though there are no regular dividends but if the project succeeds, your investment will multiply over time. ⁽¹⁴⁾

REITs focus on building income-generating properties. From which they can earn a consistent income via rent. For example, A REIT might own a shopping mall and lease stores to luxury brands, and investors get consistent dividends from rent. Whereas REOC might buy land, build a shopping mall, and sell it for a huge profit.  ⁽¹⁴⁾

Thus, REITs give you a steady income and are less hassle. However, REOC has a higher risk; however, if the project is successful, it can yield returns in multiple folds.

Future Trends in REITs
As the real estate landscape evolves, REITs are adapting to new market dynamics, technological developments, and sustainability initiatives.

·       Growth of REITs in emerging markets - Emerging markets, such as India, are witnessing rapid urbanization and a rising demand for commercial properties, making REITs an attractive investment vehicle. The Gross Asset Value (GAV) has increased by 36% since its inception in India. ⁽¹⁵⁾

·       Technological Developments in Real Estate Investments - AI, big data, and blockchain optimize property management and enhance investment strategies for REITs. Blockchain is also being used for secure transactions and lease agreements. ⁽¹⁶⁾

·       Sustainability and Green REITs- With growing environmental concerns, REITs are prioritizing sustainable development, trying to keep every investment eco-friendly, and focusing on energy-efficient buildings. ⁽¹⁷⁾

Conclusion
Real Estate Investment Trusts (REITs) have transformed the real estate market by providing investors with a unique way of generating income through real estate investments without directly owning them. This provides them with diversification, liquidity, and passive income. However, like every other investment, it comes with risks like market dynamics, interest rate sensitivity, and tax implications, which investors must carefully assess before making any decisions. Looking ahead, REITs are expected to evolve continuously, making them a crucial player in global real estate markets.

Sources:

1.      History of REITs & Real Estate Investing, Nareit

2.      REIT: What It Is and How to Invest, Investopedia, July 19, 2024

3.      What are the Different Types of REITs?, Nareit

4.      Why REITs Are a Smart Real Estate Investment Choice, CapWolf, April 22, 2025

5.      Real Estate Investment Trust (REIT): Criteria, Working, Types, Advantages & Limitations, GeeksforGeeks, July 23, 2025

6.      Understanding Real Estate Investment Trusts (REITs), ALT Investor, July 3, 2024

7.      REIT Revolution: Capital Appreciation in Real Estate Investment Trusts, Faster Capital, April 12, 2025

8.      Are REITs a Good Investment?, The Motley Fool, May 14, 2025

9.      9 Reasons Why You Should Invest in REITs: Are REITs a good investment in 2024, Mama Investing, October 1, 2024

10.   REIT Stocks in India (2025): Top Real Estate Trusts with Live Share Price, Smallcase, May 30, 2025

11.   Disadvantages of REITs, Investing Council, May 5, 2024

12.   Challenges of Investing in REITs: Risks and Considerations, Accounting Insights, January 16, 2025

13.   Real Estate Investment Trusts (REITs): Types, Benefits, Risks & Tax Implications, TaxGuru, Dec 5, 2023

14.   REIT vs REOC, Corporate Finance Institute

15.   Evolution of REIT in India: From Inception to Current Trends, India Brand Equity Foundation, July 15, 2024

16.   Navigating Challenges and Opportunities: The Future of REITs, Onwish, September 23, 2024

17.   REIT Industry Sustainability Report 2024, Nareit

Disclaimer: This article is for educational purposes only and is based on publicly available sources. While efforts have been made to ensure accuracy, the content should not be considered professional advice.