REITs and Real Estate Funds: Passive Property Investing

Want real estate in your portfolio without the headaches of property ownership? REITs (Real Estate Investment Trusts) and real estate funds let you invest in commercial buildings, apartments, warehouses, and more—with as little as $50 and the click of a button.

What Is a REIT?

How REITs Work:

1. REIT company raises capital from investors
2. Uses capital to buy/develop properties
3. Collects rent from tenants
4. Pays out most income as dividends to shareholders

You Get:

• Share of rental income (dividends)
• Share of property appreciation (stock price)
• Professional management
• diversification across many properties
• liquidity (sell anytime for publicly traded REITs)

Types of REITs

By Property Type

By Structure

Equity REITs (Most Common):

• Own and operate properties
• Income from rent
• 95%+ of REIT market

mortgage REITs (mREITs):

• Own mortgages, not properties
• Income from interest payments
• Higher yields, higher risk
• More volatile

Hybrid REITs:

• Own both properties and mortgages
• Less common

Public vs. Private REITs

Recommendation: Stick to publicly traded REITs or REIT ETFs for most investors.

How to Invest in REITs

Option 1: Individual REITs

Buy shares of specific REIT companies:

Pros:

• Control over exactly what you own
• Can target specific sectors
• Potential for higher returns if you pick well

Cons:

• Requires research
• Less diversification
• Higher risk than funds

How: Buy through any brokerage like Fidelity, Schwab, Vanguard

Option 2: REIT ETFs (Recommended)

Buy a fund that holds many REITs:

Popular REIT ETFs:

Pros:

• Instant diversification
• Very low fees
• Professional management
• Extremely liquid

Cons:

• Less control over holdings
• Own some underperformers

Option 3: REIT Mutual Funds

Actively managed real estate funds:

Examples:

• FRESX (Fidelity Real Estate Investment)
• VGSLX (Vanguard Real Estate Index Admiral)

Higher fees than ETFs but similar approach.

Option 4: Real Estate Crowdfunding

Platforms that pool investor money:

Platforms:

Pros:

• Access to deals not available publicly
• Often invest in specific properties
• Some offer higher returns

Cons:

• Limited liquidity (money locked up)
• Higher fees
• Less regulation
• Newer platforms = less track record

REIT dividend Taxation

Tax Treatment:

• Most REIT dividends: Ordinary income rates
• Some portion may be: Return of capital (tax-deferred)
• Some portion may be: Capital gains (favorable rates)

Best Practice:

• Hold REITs in 401(k), IRA, or Roth IRA
• If in taxable account, accept the tax drag
• The diversification benefits often outweigh tax cost

REIT Performance and Risks

Historical Returns

REITs have historically performed well:

• Long-term returns: 8-11% annually (similar to stocks)
• Higher dividend yields than stocks: 3-5% typically
• Low correlation with stocks (diversification benefit)

REIT Risks

Interest Rate Sensitivity:

• When rates rise, REIT prices often fall
• Higher rates = higher financing costs for REITs
• Higher rates = bonds become more competitive for income

Economic Sensitivity:

• Recessions hurt rental income
• Vacancies increase during downturns
• Some sectors more cyclical (hotels, offices)

Sector-Specific Risks:

• Retail REITs: E-commerce disruption
• Office REITs: Remote work trends
• Hotel REITs: Travel volatility

Leverage Risk:

• REITs use debt to buy properties
• High debt = higher risk during downturns

How Much Should You Allocate to REITs?

Note: If you own a total stock market index fund (like VTI), you already have ~3-4% REIT exposure built in.

Adding REITs Separately

Reasons to overweight REITs:

• Want more income
• Believe in real estate long-term
• Want diversification beyond stocks/bonds
• Don't own property directly

Reasons to stay at market weight:

• Simplicity
• Own rental property already
• Tax-efficiency concerns

Building a REIT Portfolio

Simple Approach (One Fund)

Just buy a diversified REIT ETF:

• VNQ or SCHH for broad exposure
• Covers all sectors automatically
• Rebalances for you

Sector Approach (More Control)

Tilt toward sectors you like:

Example Allocation:

Avoid or underweight:

• Traditional retail (mall decline)
• Office (remote work uncertainty)

Income Approach (Dividend Focus)

Select higher-yielding REITs:

• Realty Income (O) - Monthly dividend
• AGNC Investment - High yield mREIT (risky)
• Public Storage (PSA) - Strong track record

REITs vs. Owning Rental Property

When REITs Are Better:

• You want simplicity
• You have less capital
• You want liquidity
• You don't want to be a landlord

When Rental Property Is Better:

• You want control
• You can add value (repairs, management)
• You want maximum tax benefits
• You have the capital and skills

Getting Started with REITs

The Bottom Line

REITs and real estate funds offer the easiest path to real estate investing. With a single ETF purchase, you can own pieces of hundreds of properties across the country. You'll collect dividends, benefit from property appreciation, and never deal with a tenant or leaky roof. For most investors, a low-cost REIT ETF deserves a place in a diversified portfolio—typically 5-15% for those wanting real estate exposure beyond what's already in total market funds.