The $4 trillion real estate sector is beating the S&P 500 this year. Is it time to put REITs back in your portfolio?
When the U.S. Congress created a structure called a REIT in 1960, it had a simple aim: to let someone who would never have millions for a whole building buy a stake in an office tower or shopping center. Since then, this unassuming tax structure has grown into a sector managing four trillion dollars in real estate, paying tens of billions in dividends annually to retail investors, yet many still have only a vague notion of it. Meanwhile, REITs have had their own roller‑coaster ride: they outperformed almost everything on the stock exchange in 2021, then lost a quarter of their value the following year without any fundamental change in their business, and today they are getting back in shape as one of the unexpected darlings of an environment where investors are again looking for stable income and hard assets.
Key points
REITs are required by law to pay out at least 90% of their taxable income, so a dividend yield of ~4% is more than triple that of the S&P 500.
Over a 25‑year horizon they have returned 9.5% per year versus 7.9% for the S&P 500, with dividends supplying roughly half of the return.
In 2022 the sector shed 25%, even though corporate earnings were growing. This year, on the other hand, it is beating the market by more than 4%.
The key to picking them is not P/E but FFO, payout ratio, and the maturity profile of the debt. We break down how to do it.
Risk: the Fed is holding rates at 3.50–3.75% and the market has recently started pricing in a possible hike, which is a short‑term headwind for REITs.
Real estate investment trusts, known by their acronym REIT, offer investors a slice of commercial property for the price of a single share and a dividend yield that today averages three times that of the S&P 500. At the same time they have a reputation as the sector that lost a quarter of its value in 2022 and has trailed the broad market by tens of percentage points since rates started rising. In this analysis we take a look at how REITs work, why the law requires them to pay out most of their earnings, how they react to interest rates, which metrics to use to evaluate them, and what mistakes investors make most often.
What is a REIT and why does it exist at all?
A structure born of legislation
A REIT (Real Estate Investment Trust) is not an ordinary public company but a special legal and tax structure that the U.S. Congress created in 1960. The goal was to make the returns from commercial real estate accessible even to small investors, because until then office buildings, shopping centers, or apartment complexes were practically available only to institutions and very wealthy individuals. Today publicly traded U.S. REITs, according to industry association Nareit, own commercial real estate worth roughly 4 trillion dollars and form a separate sector of the S&P 500 index.
To obtain REIT status a company must meet a strict set of conditions. At least 75% of its assets must be real estate, cash, or U.S. government securities, at least 75% of its gross income must come from rents, mortgage interest, or property sales, and the company must have at least 100 shareholders, with the five largest holding no more than half of the shares. So it is not a marketing label but a legal regime whose violation means losing the tax advantages.
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