REITs 101: How They Work

If you’re new to REITs or you’ve bought a few dividend stocks and want to understand how public REITs work, this post is for you. We promise we’ll keep the jargon minimal and show you exactly what a REIT is, why you should care and even how to evaluate such companies.

What is a REIT?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. In the U.S., a company elects REIT status and must meet ongoing rules (e.g., focus on real estate assets and income; pay out ≥90% of taxable income as dividends). In return, REITs generally avoid corporate income tax, and investors are taxed on dividends they receive.

There are two big buckets here you should be aware of:

• Equity REITs: Own and operate properties. Most REITs fall in this category, with the vast majority of revenue coming through a rent scheme.
• Mortgage REITs (mREITs): Finance real estate by holding mortgages or MBS. Revenue is interest income and is more rate-sensitive.

Specialized REITs focus on niches like net-lease retail, data centers, healthcare, industrial/logistics, cell towers, self-storage, apartments, single-family rentals, and more.

A quick bit of history: REITs were created in the United States when President Dwight D. Eisenhower signed Public Law 86-779 (the “Cigar Excise Tax Extension of 1960”). The law allowed everyday investors to buy and sell shares of large, diversified portfolios of income-producing real estate as liquid securities. The first REIT, American Realty Trust, was founded in 1961 by Thomas J. Broyhill, who—along with his cousin, U.S. Congressman Joel Broyhill of Virginia—helped push for the legislation under Eisenhower.

President Dwight D. Eisenhower signed Public Law 86-779 of 1960, enablisng the creation of REITs

Why do investors buy REITs?

• Regular cash payouts: REITs must pay out most of their profits, so investors often get steady dividends.
• Real estate exposure: You’re buying into real buildings (malls, data centers, apartments, clinics) without owning property yourself.
• Diversification: REITs don’t always move the same way as the broader stock market.
• Pros at the wheel: Experienced teams handle buying, leasing, and financing the properties.

Trade-offs & risks:

• Interest rates: If rates rise, borrowing gets pricier and REIT prices can fall.
• Debt: Many REITs use leverage; too much can be risky in a downturn.
• Tenant risk: If major tenants leave or fail, rent drops.
• Lease timing: Rents are often fixed until renewal; bad timing can hurt results.
• Development risk: New projects can run late or over budget.
• Valuation swings: Market moods change—P/FFO (price divided by funds from operations) can move up or down.

The REIT metrics that matter

Quick intro: Before you think of buying shares of any REIT, scan these core numbers below. They tell you (1) how much cash it really makes, (2) how safe the dividend looks, (3) how well the properties are doing, (4) how risky the debt is, and (5) whether the stock looks cheap or expensive. Tiny examples included.

Cash flow (look past EPS)

• FFO (Funds From Operations): Cash-style profit from properties.
  Example: Net income $300m + depreciation $200m - gains on sales $20m = $480m FFO. With 480m shares, that’s $1.00 FFO/share.
• AFFO (Adjusted FFO): FFO minus routine upkeep and other small tweaks. Often the base for dividends.
  Example: FFO/share $1.00 - maintenance $0.10 - other $0.02 ⇒ $0.88 AFFO/share.

Dividend health

• Payout ratio (AFFO): Dividends ÷ AFFO. Many equity REITs are around 60–85%.
  Example: Dividend $0.70, AFFO $1.00 ⇒ 70%. If AFFO drops to $0.80 and dividend stays $0.70, it jumps to 88% (tighter).

Property performance

• Occupancy: How full the buildings are.
  Example: 100 units, 95 rented ⇒ 95%.
• Same-store NOI growth: Income change from the same properties vs. last year.
  Example: +3% = getting healthier; -2% = soft patch.

Balance sheet & interest-rate exposure

• Net debt / EBITDA: Debt load vs. cash earnings. Lower is safer.
  Example: Net debt $5b, EBITDA $1b ⇒ 5×.
• Interest coverage: Ability to pay interest. Higher is safer.
  Example: EBITDA $1b, interest $250m ⇒ 4×.
• Debt maturity ladder: When debt comes due.
  Example: Big lump due next year = higher refinancing risk; spread-out ladder = smoother.
• Fixed vs. floating: How sensitive interest costs are to rate moves.
  Example: 80% fixed = more protected; 50% floating = more rate-sensitive.

Valuation

• P/FFO: Price ÷ FFO per share.
  Example: Price $30, FFO/share $2.00 ⇒ 15×. If peers are 18×, this one might be cheaper—check why.
• EV/EBITDA: Helps compare REITs with different debt levels.
• Price/book (mREITs): Market price vs. book value (more useful for mortgage REITs).
  Example: 0.9× book = discount (market fears BV could fall); 1.2× = premium (quality/growth).

Tip: Look at trends over years, not just one quarter. Compare a REIT to its own history and to direct peers.

Two iconic REIT companies

Realty Income (O) - the classic monthly dividend net-lease REIT

Realty Income company page at Smartfin

Business model: Realty Income buys single-tenant, freestanding properties and leases them out on long-term triple-net contracts—tenants pay taxes, insurance, and maintenance, while Realty Income collects predictable rent with small annual increases. The portfolio focuses on everyday, service-oriented categories (grocers, convenience, dollar stores, quick-serve restaurants, pharmacies) that tend to be resilient through cycles.

History: Founded in 1969 and listed in 1994, the company built its brand around paying a monthly dividend and scaled through steady acquisitions and selective big deals (including a major merger in 2021) and has since expanded into parts of Europe.

Current outlook: With built-in rent escalators, internal growth is steady; external growth depends on the gap between acquisition yields and the company’s cost of capital. Watch interest rates (financing costs), tenant health in core categories, and lease maturities. In calmer rate environments, O typically leans into acquisitions; when rates are higher, it prioritizes balance-sheet strength and disciplined deal flow.

Quick metrics (as of Aug 19, 2025)

• Dividend yield: ~5.5%
• AFFO payout ratio: ~76%
• Net debt/EBITDA: ~5.5×

Welltower Inc. (WELL) - healthcare & senior housing platform

Welltower Inc. company page at Smartfin

Business model: Welltower owns senior housing, outpatient medical, and post-acute care properties. Cash flow is driven by demographics (aging population), operator quality, and local market supply/demand. In senior housing, some assets are operated through structures where cash flows are more “hotel-like” (sensitive to occupancy and rates), while others are leased on triple-net terms.

History: One of the oldest healthcare REITs (founded in 1970), the company rebranded from Health Care REIT to Welltower in 2015 to reflect a broader healthcare-real estate strategy and an expanded operator network.

Current outlook: The aging 80+ population is a long-term tailwind for senior housing demand. Near term, watch occupancy recovery, same-store NOI in the operating portfolio, labor costs at operators, and the pace/returns of redevelopment. A stronger balance sheet and well-matched operator partnerships help, but results can swing with local supply and healthcare staffing trends.

Quick metrics (as of Aug 19, 2025)

• Dividend yield: ~1.8%
• AFFO payout ratio: ~58%
• Net debt/EBITDA: ~2.9–3.1×

How REITs actually make (and pay) money

The simple flow:

1. Collect rent (or interest for mREITs)
2. Pay property costs (maintenance, taxes, insurance, staff)
3. what’s left at the property level is Net Operating Income
4. Pay corporate costs & interest
5. arrive at FFO (cash-style earnings for REITs)
6. adjust for routine upkeep to get AFFO
7. pay dividends
8. reinvest the rest in new deals or projects

Tiny example: Rent is $1,000 this period. Property costs are $300 ⇒ NOI $700. Corporate costs & interest total $250 ⇒ FFO $450. Routine maintenance is $50 ⇒ AFFO $400. If the REIT pays 70% of AFFO, dividends are $280, leaving $120 to reinvest or reduce debt. (FFO adds back non-cash depreciation; AFFO further subtracts recurring maintenance.)

Why dividends are central: To qualify as a REIT, a company must distribute at least 90% of its taxable income to shareholders each year. That rule is why many REITs pay regular, often sizable dividends. Note: for investors, REIT dividends are usually taxed as ordinary income (check your situation).

A steady and predictable stream of dividends by Welltower Inc. (screenshot by Smartfin)

Where growth comes from:

• Same-store improvements: Annual rent bumps, better occupancy, and higher re-lease rates at existing properties.
• External growth: Buying or developing properties when expected returns beat the REIT’s cost of capital (what it costs to raise debt/equity).
• Capital recycling & scale: Selling lower-return assets to fund higher-return ones; using platform advantages (tenant relationships, data, operating know-how).

Focus on whether FFO/AFFO per share is rising over time—this supports sustainable dividend growth.

Quick watch-outs: Interest rates (they affect borrowing costs and valuations), leverage, tenant health, and the timing of lease renewals can all sway results.

A quick, practical REIT checklist

Use this 60-second scan on any REIT company:

1. Dividend: Yield today vs. history; payout ratio vs. AFFO.
2. Cash Flow: AFFO/share trend (3–10y). Is it rising steadily?
3. Balance Sheet: Net debt/EBITDA; fixed/floating; maturity wall.
4. Portfolio Quality: Occupancy; tenant/sector diversification; WALT.
5. Valuation: P/FFO vs. own history and sector peers.
6. Catalysts/Risks: Development pipeline, rate sensitivity, tenant risk

Some Common misconceptions

• “EPS drives valuation.”
  For REITs, FFO/AFFO are better profit gauges because they add back non-cash real estate depreciation and strip out one-off gains/losses that distort EPS. Use P/FFO (or AFFO per share trends) instead of P/E for a clearer view.
• “High yield is always better.”
  A sky-high yield can be a warning sign (price fell on bad news, dividend not covered, or due for a cut). Check payout ratio vs. AFFO and the trend in FFO/AFFO per share to judge sustainability—not just the yield number.
• “Rates up = all REITs down.”
  Rising rates often come with stronger growth, which can support REIT earnings and dividends; historically, REITs have still posted positive returns in many rising-rate periods. Rate sensitivity varies by lease terms, duration, and sector.
• “All REITs are malls.”
  The listed REIT universe spans data centers, towers, logistics, health care, storage, apartments, hotels, infrastructure, and more. Know the property type you’re buying—each behaves differently.

Simple checklist: use P/FFO (or AFFO), verify dividend coverage (dividends ÷ AFFO), consider rate exposure (fixed vs. floating debt, lease length), and always note the sector you’re in.

Disclaimer: This guide is for educational purposes only and is not investment advice. Do your own research and consider your financial situation and risk tolerance.