When you invest in a REIT (real estate investment trust), you are investing in income-generating real estate. REITs often invest in commercial properties with long-lease periods, so the income for the investor is ongoing and fairly predictable. Publicly traded REITs pay out dividends on a regular basis, because they have to pay out 90 percent of their net income to all the shareholders in order to retain REIT pass-through taxation status. This means that REITs don't have to pay federal taxes and there are more profits to pay out in dividends to shareholders.
Investors in REITs potentially have a steady stable income that doesn't usually lose its value even in times of high inflation, because income from rent can be adjusted to the cost-of-living. The shares can also appreciate in value. Sometimes a certain portion of the dividends can be considered a nontaxable return of capital. This means that the shareholder does not have to pay taxes that year on those dividends, and will not have to pay taxes until the shares are sold. As long as the investor hangs on to the REIT stock, return of capital also lowers the investor's taxable income. This in effect raises the dividend yield.
When choosing what REITs to invest in, it's important to know how they earn their profits and what dividends you can expect to earn. REITs can invest in different types of commercial properties in different demographic areas, which are factors that can impact the rental rates and occupancy and affect the profits and shareholder dividends. Investors often invest in more than one REIT. Before making a decision, it's a good idea to look at past yields, and look out for especially high yields that may indicate that the REIT is selling property to generate income. This would have an effect on future rental income. It's also important to know what management compensation is based on. This could affect the management's actions, whether to increase dividend yield or concentrate on total asset value for capital appreciation.