Pros and Cons of REITs: Income, Taxes, Rate Risk and Non-Traded REIT Traps

A real estate investment trust (REIT) is a company that owns or finances income-producing real estate and passes most of its income to shareholders. That structure is set by the tax code, and it explains both the main attraction of REITs (high, regular dividends) and most of their drawbacks (heavy taxes on those dividends, reliance on borrowing, sensitivity to interest rates). Nareit, the industry's trade group, estimates that about 170 million Americans live in households that own REITs, mostly through retirement accounts and funds.

The Short Answer

• Pros: real estate exposure for the price of one share, dividends that must equal at least 90% of taxable income, daily liquidity for listed REITs, and access to property types an individual cannot buy (data centers, cell towers, warehouses).
• Cons: dividends are generally taxed as ordinary income, prices swing with the stock market and interest rates, and paying out most income means growth is funded with debt and new shares.
• Tax help: qualified REIT dividends get a 20% deduction under section 199A, and the 2025 tax law removed that deduction's 2025 end date.
• Avoid surprises: non-traded REITs are hard to sell and typically charge about 9% to 10% in up-front fees.

What Makes a Company a REIT

A company qualifies as a REIT under sections 856 and 857 of the Internal Revenue Code. The key requirements:

• Pay out income: its dividends must be at least 90% of its REIT taxable income (excluding net capital gains). In return, the REIT can deduct those dividends, so it pays little or no corporate tax.
• Own mostly real estate: at the end of each quarter, at least 75% of its assets must be real estate, cash or government securities.
• Be widely owned: at least 100 shareholders.

Nareit puts the gross assets owned by U.S. REITs of all types at more than $4.5 trillion, with listed REITs worth more than $1.4 trillion in stock market value.

Types of REITs

Type	What it owns	Main risk
Equity REIT	Buildings it rents out: apartments, warehouses, offices, stores, data centers, towers, health care	Vacancies, rents and property values in its sector
Mortgage REIT	Mortgages and mortgage-backed securities	Interest rate moves and borrowing costs; often high leverage
Listed (publicly traded)	Either of the above, traded on an exchange	Daily price swings
Public non-traded	SEC-registered but not exchange-listed	Illiquidity, high fees, hard-to-know value
Private	Not SEC-registered; usually for accredited investors	Little disclosure, illiquidity

Pros

• Income by design. The 90% payout rule means most of the rent or interest a REIT earns reaches shareholders as dividends.
• No landlord work. No tenants, repairs or mortgage applications; a share of a REIT fund can own hundreds of properties.
• Liquidity. Listed REITs and REIT funds can be sold any trading day, unlike a rental property that can take months to sell.
• Small minimum. One share or a few dollars in a fund, against a down payment for a property.
• Access to specialized property. Cell towers, data centers, logistics warehouses and medical buildings are mostly reachable only through REITs.
• Transparency. Listed REITs file audited reports with the SEC.

Cons

• Interest rate sensitivity. REITs borrow to buy property, so higher rates raise their costs, and higher bond yields make REIT dividends less attractive by comparison. Mortgage REITs are the most exposed.
• Stock market swings. Listed REITs trade like stocks and can fall sharply in a sell-off even when rents hold up.
• Little retained cash. Paying out at least 90% of income leaves less to reinvest, so growth depends on new debt or new shares, which can dilute existing holders.
• Tax-inefficient dividends in a taxable account (see the next section).
• Sector concentration. A single-sector REIT, such as offices or malls, rises and falls with that sector.
• No control. Management decides what to buy, sell and borrow.

How REIT Dividends Are Taxed

• Mostly ordinary income. The SEC's investor.gov notes that REIT dividends "generally are treated as ordinary income" and do not get the lower rates on qualified dividends. Part of a payout may instead be a capital gain distribution or a return of capital; your Form 1099-DIV breaks it down.
• The 20% deduction. Section 199A lets you deduct 20% of qualified REIT dividends, and this part of the deduction is not limited by the REIT's wages or property. In practice, a taxpayer in the 37% bracket pays an effective 29.6% on those dividends (37% on the remaining 80%).
• It no longer ends in 2025. The 2025 tax law (Public Law 119-21, section 70105) rewrote the subsection that would have ended section 199A after 2025, so the deduction continues.
• Where to hold them. Because most of the return arrives as ordinarily taxed income, many investors keep REITs in an IRA or 401(k), where dividends are not taxed each year. See our guide to tax-efficient investing.

Non-Traded REITs: Read This First

Non-traded REITs are often sold by brokers on the strength of steady, high distributions. The SEC's investor.gov lists the risks:

• Illiquid: they generally cannot be sold readily on the open market, so you may not be able to raise cash from them quickly.
• Hard to value: they typically do not give a per-share value until 18 months after the offering closes, which may be years after you buy.
• Distributions may not be earned: they often pay more than their funds from operations, using offering proceeds or borrowing.
• High fees: sales commissions and offering costs usually total about 9% to 10% of the investment.
• Conflicts of interest: an external manager may be paid more for buying more property.

How to Invest and How Much

1. Start with a REIT index fund or ETF rather than single REITs; it spreads money across property types and companies.
2. Check what you already own. A total U.S. stock market fund already holds listed REITs, so a separate REIT fund is an overweight, not a first slice of real estate.
3. Size it as a slice, not a core holding. REITs are stocks with a real estate tilt and can fall with the market.
4. Prefer tax-advantaged accounts for REIT funds when you have the choice.
5. Look at FFO, not earnings. REITs report funds from operations, which adds back depreciation; a dividend well above FFO is a warning sign.

If you want to compare REITs with owning a rental yourself, our guide is real estate a good investment? walks through the numbers.

FAQ

Are REITs a good investment?
They can be a useful income and diversification slice, especially in tax-advantaged accounts. They are not low risk: listed REITs move with the stock market and interest rates.

How much of their income do REITs have to pay out?
At least 90% of their REIT taxable income, excluding net capital gains, under section 857 of the tax code.

Are REIT dividends qualified dividends?
Generally no. Most are taxed as ordinary income, but qualified REIT dividends get a 20% deduction under section 199A, which continues after 2025.

What is the biggest risk of a non-traded REIT?
You may not be able to sell when you want, and up-front fees of about 9% to 10% mean you start well behind.

Do REITs do badly when interest rates rise?
Rising rates usually hurt REIT prices because borrowing gets more expensive and bonds compete for income investors. Mortgage REITs are the most sensitive.

Sources

• 26 U.S.C. 857, taxation of REITs (90% distribution requirement)
• 26 U.S.C. 856, definition of a REIT
• SEC investor.gov, Real Estate Investment Trusts (REITs)
• IRS, Qualified business income deduction
• Public Law 119-21, section 70105
• Nareit, What's a REIT?

This article is general information, not investment or tax advice. Tax rules were checked against the sources above on 2026-10-23. Investing involves risk, including loss of principal, and past performance does not guarantee future results.