How to Invest: Real Estate (REITs)

February 09, 2026

Welcome to How to Invest. In this article:

  • Main Feature: REITs: Being a Landlord Without the Headaches

  • Investment Ideas for All Budgets

  • Educational Corner: Why "Net Income" Lies (Understanding FFO)

  • Did You Know? A Quick Financial Fact

REITs: Being a Landlord Without the Headaches

For generations, real estate has been considered one of the surest paths to wealth. However, the traditional barrier to entry is high: you need a massive down payment, good credit, and the patience to deal with leaking toilets and late rent checks. Enter the Real Estate Investment Trust (REIT). Created by Congress in 1960 to democratize access to real estate, REITs allow the average person to own shares in billion-dollar property portfolios—shopping malls, skyscrapers, hospitals, and warehouses—just by buying a stock. This section explores how you can add real estate to your portfolio to generate high income and protect against inflation, all without ever answering a tenant's phone call.

What Is a REIT?

A REIT (pronounced "treat" without the "t") is a company that owns, operates, or finances income-producing real estate. To qualify as a REIT and avoid paying corporate income tax, a company must comply with strict IRS rules:

  • The 90% Rule: They must distribute at least 90% of their taxable income to shareholders annually in the form of dividends.

  • Asset Test: At least 75% of their total assets must be invested in real estate or cash.

  • Income Test: At least 75% of their gross income must come from rents, interest on mortgages, or real estate sales.

Types of REITs

Not all real estate is the same. REITs are often categorized by the specific type of property they own:

  • Retail REITs: Own shopping malls and strip centers (e.g., Simon Property Group).

  • Residential REITs: Own apartment buildings, student housing, and single-family rental homes.

  • Industrial REITs: Own logistics warehouses and distribution centers (crucial for e-commerce).

  • Healthcare REITs: Own hospitals, nursing homes, and medical office buildings.

  • Data Center REITs: Own the secure facilities that house the servers powering the internet.

  • Mortgage REITs (mREITs): Unlike "Equity REITs" that own buildings, these companies lend money for mortgages. They act more like banks and are sensitive to interest rates.

Why Invest in REITs?

  1. High Dividend Yields: Because they are legally required to pay out 90% of income, REITs often offer yields significantly higher than the S&P 500 or standard bonds.

  2. Inflation Hedge: Real estate rents and property values tend to rise with inflation. As the cost of living goes up, landlords can raise rents, passing that income on to you.

  3. Diversification: Real estate often follows a different cycle than technology or industrial stocks. Adding it reduces the overall volatility of your portfolio.

  4. Liquidity: Unlike owning a rental house, which takes months to sell, you can sell your share of a REIT in seconds during market hours.

Risks and Considerations

  1. Interest Rate Sensitivity: REITs are highly sensitive to interest rates. When rates rise, borrowing money to buy buildings becomes more expensive, and dividend yields become less attractive compared to "risk-free" Treasury bonds.

  2. Sector Risk: Not all properties perform well at the same time. During the pandemic, Office REITs crashed while Data Center and Industrial REITs soared.

  3. Tax Inefficiency: Because REITs don't pay corporate tax, their dividends are usually taxed at your ordinary income tax rate, not the lower "qualified dividend" rate.

  4. Depreciation Trap: On paper, buildings lose value (depreciation). This makes accounting tricky (explained in the Educational Corner).

Building a REIT Portfolio

  1. Core Holdings: Start with a broad exposure to diversified real estate to mitigate risk.

  2. Select High-Growth Sectors: Look for "megatrends." For example, the aging population supports Healthcare REITs; the growth of AI supports Data Center REITs.

  3. Watch the Debt: Real estate is a leverage-heavy business. Look for REITs with strong credit ratings (BBB or higher) and manageable debt levels.

  4. Tax Location: Because of the tax treatment of dividends, REITs are best held in tax-advantaged accounts like an IRA or 401(k).

Investment Ideas for All Budgets

For Small Investors (1 to 100 Dollars)

The Broad Real Estate ETF Description: Buying a single low-cost Exchange Traded Fund (ETF) that holds a basket of over 100 different REITs across all sectors. Advantages:

  • Instant Empire: With one purchase, you own a piece of thousands of properties across America.

  • Sector Balance: You get exposure to everything—from cell towers to timberlands—without having to pick the winner.

  • Low Cost: Expense ratios are minimal (often <0.15%).

  • Quarterly Income: Provides a steady stream of dividend payments.

Limitations:

  • Market Weighting: You will be heavily invested in the largest sectors (like Telecom towers) even if you prefer Apartments.

  • Average Yield: You cannot target ultra-high yields found in specific distressed sectors.

Implementation:

  • Open a brokerage account.

  • Purchase a leading Real Estate ETF:

    • Vanguard Real Estate ETF (VNQ): The industry standard for US exposure.

    • Schwab US REIT ETF (SCHH): A low-cost alternative.

  • Set dividends to automatically reinvest (DRIP).

For Medium Investors (101 to 10,000 Dollars)

The "Monthly Dividend" Strategy Description: Focusing on specific high-quality REITs known for paying dividends every single month rather than quarterly. The most famous of these is Realty Income Corporation (Ticker: O). Advantages:

  • Cash Flow Match: Monthly payments align with your real-life bills (rent/mortgage, utilities).

  • Triple Net Lease Safety: Many of these REITs use "Triple Net Leases," where the tenant (not the landlord) pays for taxes, insurance, and maintenance. This creates very stable cash flow.

  • Compound Speed: Reinvesting dividends monthly compounds faster than quarterly.

Limitations:

  • Single Stock Risk: If that one company fails or loses a major tenant (like a pharmacy chain going bankrupt), your investment suffers.

  • Slow Growth: Stable, high-dividend payers usually grow their share price slower than risky tech stocks.

Implementation:

  • Research "Triple Net Lease" REITs.

  • The Classic Pick: Realty Income (O). Known as "The Monthly Dividend Company," it has paid over 600 consecutive monthly dividends.

  • Alternative: Stag Industrial (STAG). Focuses on industrial warehouses and also pays monthly.

  • Invest a fixed amount to build a specific monthly income goal (e.g., "I want this position to pay my Netflix bill").

For Large Investors (10,000 Dollars and Above)

The "Megatrend" Sector Rotation Description: Constructing a custom portfolio of individual REITs to target specific economic themes ("Megatrends") while ignoring dying sectors (like Class B shopping malls or old office parks). Advantages:

  • Alpha Potential: By overweighting high-growth sectors (Data Centers, Cell Towers) and underweighting low-growth ones (Office), you can significantly outperform the standard index.

  • Tax Optimization: You can place high-yield REITs in your IRA and lower-yield, high-growth REITs in your taxable account.

  • Quality Control: You can insist on only owning companies with "Fortress Balance Sheets."

Limitations:

  • Research Intensive: Requires reading quarterly supplements to understand occupancy rates and lease expirations.

  • Valuation Risk: "Hot" sectors like Data Centers often trade at very high multiples, increasing downside risk if growth slows.

Implementation:

  • Allocating the Portfolio (Example):

    • 30% Residential: (e.g., Mid-America Apartment Communities - MAA) for stability.

    • 25% Industrial: (e.g., Prologis - PLD) for e-commerce growth.

    • 20% Digital Infrastructure: (e.g., Equinix - EQIX) for the AI boom.

    • 15% Healthcare: (e.g., Welltower - WELL) for aging demographics.

    • 10% Speculative/High Yield: (e.g., VICI Properties - VICI) casinos/entertainment.

  • Monitor: Watch "Funds From Operations" (FFO) growth, not just EPS.

Educational Corner: Why "Net Income" Lies (Understanding FFO)

If you look at the P/E (Price to Earnings) ratio of a REIT, it often looks terrifyingly high or even negative. Do not panic.

In standard accounting (GAAP), companies must deduct Depreciation from their earnings.

  • If a factory buys a machine, that machine rusts and loses value. Depreciation accounts for this.

  • However, well-maintained real estate usually gains value over time.

Because REITs own massive amounts of real estate, they record massive depreciation charges. This artificially lowers their "Net Income" on paper, even though the cash in their bank account is piling up.

The Solution: Funds From Operations (FFO) REIT investors ignore "Net Income" and use FFO.

  • Calculation: Net Income + Depreciation + Amortization - Gains from Property Sales.

  • Why it matters: FFO tells you the actual cash flow generated by the operations of the buildings.

The Takeaway: Never judge a REIT by its P/E Ratio. Judge it by its Price-to-FFO (P/FFO) ratio. A REIT with a P/E of 50 might have a P/FFO of only 15, making it a bargain.

Did You Know?

The Empire State Building, perhaps the most famous office building in the world, is owned by a publicly traded REIT.

The Empire State Realty Trust (Ticker: ESRT) owns the landmark skyscraper along with several other properties in New York City. This means that for the price of a few cups of coffee (shares trade around $10), you can technically say you are a part-owner of the Empire State Building. You won't get a key to the penthouse, but you will get a share of the profits from the observation deck tickets and the office rents paid by tenants like LinkedIn and Shutterstock.

That concludes this article of How to Invest. Real Estate Investment Trusts offer a powerful way to diversify your portfolio, moving beyond just stocks and bonds into the world of tangible assets. Whether you are seeking the passive income of a landlord or the growth of digital infrastructure, REITs provide the vehicle to get there with liquidity and transparency. Remember to look past the "Net Income" confusion, focus on the quality of the properties, and let the tenants pay your dividends.