REITs (pronounced “reets”) are companies that own, operate, or finance income-producing real estate. Think of them as a mutual fund for real estate properties. Instead of buying a single apartment building yourself, you can buy shares in a REIT that owns hundreds of them, along with office towers, shopping malls, warehouses, or even data centers. The magic of the REIT structure lies in its tax treatment. To qualify as a REIT, a company must pay out at least 90% of its taxable income to shareholders as Dividends. In return, the company pays little to no corporate income tax. This structure effectively passes the rental income (or mortgage interest) directly to investors, making REITs famous for their high dividend yields. It's a way for any investor to become a landlord, collecting a share of the rent from a diverse portfolio of properties, all with the click of a button on their brokerage account.
The concept is beautifully simple. A REIT pools capital from numerous investors to purchase and manage a portfolio of real estate assets. This is their full-time job. They handle the property management, tenant negotiations, maintenance, and everything else that comes with being a landlord on a massive scale. The income generated, primarily from rent, flows into the REIT. After covering operating expenses, the company distributes the vast majority of the profits—that legally required 90%—to its shareholders. This mandatory payout is the key feature that distinguishes REITs from regular corporations. While a company like Apple can choose to retain its earnings to fund growth, a REIT is legally obligated to share the wealth. This makes them a favorite among income-oriented investors who rely on their portfolios for a steady cash stream.
Not all REITs are the same. They typically fall into two main categories, each with a distinct business model and risk profile.
These are the most common type of REIT and what most people think of when they hear the term. Equity REITs are in the business of owning and operating physical properties. They are the landlords of the economy. Their revenue is generated directly from the rent paid by tenants. They can specialize in specific property sectors, such as:
For a value investor, the appeal of an Equity REIT is tangible. You are buying a piece of a real, physical asset that you can understand.
Mortgage REITs, or mREITs, don't own any buildings. Instead, they are in the financing business. They lend money to real estate owners or invest in existing loans and Mortgage-Backed Securities (MBS). Their profit comes from the net interest margin—the spread between the interest they earn on their investments and the cost of funding those investments. Because they use a lot of leverage (borrowed money), mREITs can be much more volatile and are highly sensitive to changes in interest rates. They are generally considered riskier than their Equity REIT cousins.
Analyzing a REIT requires a special set of tools. Traditional metrics like earnings per share (EPS) can be misleading because of a quirky accounting rule called Depreciation. Accounting rules assume buildings lose value over time, but in reality, well-maintained properties often appreciate. This non-cash expense artificially depresses a REIT's net income.
Value investors know that cash is king. For REITs, we use specific metrics to get a true picture of cash flow.
Just as you wouldn't use a hammer to bake a cake, you don't use a P/E ratio to value a REIT. Instead, investors use:
Another powerful tool is Net Asset Value (NAV). This is an estimate of the market value of a REIT's properties minus all its liabilities. Think of it as the company's private market worth. A savvy value investor looks for opportunities to buy shares in a high-quality REIT when its stock price is trading at a significant discount to its NAV.