The Ultimate Guide to REITs: Strategies to Buy, Hold, and Profit

Real estate investment trusts (REITs) can be terrific investment vehicles. These entities hold a portfolio of income-generating commercial real estate. They use that income to pay dividends and invest in additional income-producing properties.

That combination of income and growth has enabled REITs to produce robust returns. REITs have outperformed stocks over the long term. Here are some strategies to help you make money investing in REITs.

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Dividends drive results

REITs are known for paying dividends. The IRS requires that REITs pay a minimum of 90% of their taxable income in dividends to maintain their tax advantages (REITs don't pay corporate income taxes).

Dividend payments help give REITs an advantage in producing returns for investors. Over the last 50 years, companies in the S&P 500 (SNPINDEX: ^GSPC) that paid dividends have delivered more than double the total returns as non-dividend stocks, according to data from Ned Davis Research and Hartford Funds (9.2% annualized total return versus 4.3%). Overall, dividends have contributed about 50% of REIT returns over the long term (that compares to about 34% of the S&P 500's total return since 1940).

However, there's a considerable difference in returns by dividend policy:

Data source: Ned Davis Research and Hartford Funds.

Given that data, the best way to profit from dividend stocks like REITs is to invest in those that consistently grow their dividends. Three factors tend to drive a REIT's ability to increase its dividend:

1. The quality of its portfolio: The REIT needs to own a high-quality portfolio of properties that produce durable and growing rental income. It should own properties benefiting from increasing demand, leased to a diverse set of high-quality tenants.
2. The dividend payout ratio: While REITs must distribute 90% of their taxable net income, they typically produce more cash flow than income due to depreciation. Because of that, a better gauge of dividend safety is the percentage of a REIT's funds from operations (FFO) it pays in dividends. Ideally, a REIT should have a payout ratio of 75% of its FFO or less. That gives it a cushion while allowing it to retain some cash to fund new investments.
3. The balance sheet: REITs borrow a lot of money to fund acquisitions and development projects. This means they must maintain a strong balance sheet to continue growing. A REIT should have an investment-grade bond rating backed by low leverage ratios (ideally below 5.5 times debt to income).

Two investment strategies to profit from REITs

Investors have two pathways to profit from REIT investments. They can buy individual REITs, or invest in a REIT ETF.

Investing in an exchange-traded fund (ETF) focused on REITs is the simplest way to invest broadly in the wealth-creating capabilities of REITs. These funds invest broadly in the REIT sector.

For example, Vanguard Real Estate ETF (NYSEMKT: VNQ) holds over 150 REITs. The fund has a market-weighting strategy, meaning it allocates a higher percentage of its assets in the largest REITs. Its top three REIT holdings currently are leading industrial REIT Prologis (NYSE: PLD) (6.4% of the fund), top telecom infrastructure REIT American Tower (5.4%), and giant healthcare REIT Welltower (5.2%).

This fund offers broad exposure to the REIT sector with a focus on the largest REITs for a relatively modest fee. It charges investors an ETF expense ratio of 0.13%. However, in exchange for that annual fee, investors don't have to manage a portfolio of REITs. ETFs like the Vanguard Real Estate ETF are a very passive way to invest in the REIT sector.

The other strategy investors can use to profit from REITs is building a portfolio of high-quality REITs that should be able to increase their dividends. This strategy could outperform a REIT ETF over the long term.

Realty Income (NYSE: O) is a great foundational REIT to buy. The REIT holds a diversified portfolio of high-quality properties (retail, industrial, gaming, and others).

Realty Income has a fantastic record of increasing its dividend. It recently delivered its 130th dividend increase since coming public in 1994. That steady dividend growth has contributed to Realty Income's strong total returns (13.4% annualized). The REIT has steadily grown by acquiring additional income-generating real estate.

Investors should add a few more REITs to their portfolio to increase their diversification and gain exposure to other property types benefiting from growing demand. For example, a residential REIT like Mid-America Apartment Communities (NYSE: MAA) is a great way to profit from rising demand for rental housing. The apartment REIT has increased its dividend payment for 15 straight years. It has steadily grown its rental income by raising rents and acquiring and developing new apartment communities.

Another high-quality REIT to consider is Prologis. The leading logistics REIT has grown its dividend at a 13% compound annual rate over the last five years, more than double the REIT sector average of 5%. Growing demand for warehouse space should enable Prologis to continue expanding its portfolio and dividend.

Meanwhile, leading data center REIT Equinix (NASDAQ: EQIX) recently increased its dividend by another 10%, extending its dividend growth streak to 10 straight years. The REIT is benefiting from growing demand for data center capacity to support AI and digitalization.

Investing in REITs can be a very enriching strategy

REITs have historically produced strong total returns over the long term. Dividend growth is a big driver of their ability to grow value for shareholders. The easiest strategy to profit from REITs is to buy an ETF focused on the sector. However, investors could potentially make even more money over the long term by building a portfolio of top-notch REITs in the strongest position to grow their dividends.

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Matt DiLallo has positions in American Tower, Equinix, Mid-America Apartment Communities, Prologis, and Realty Income and has the following options: long January 2026 $170 calls on American Tower and short January 2026 $175 calls on American Tower. The Motley Fool has positions in and recommends American Tower, Equinix, Mid-America Apartment Communities, Prologis, Realty Income, and Vanguard Real Estate ETF. The Motley Fool recommends the following options: long January 2026 $180 calls on American Tower, long January 2026 $90 calls on Prologis, and short January 2026 $185 calls on American Tower. The Motley Fool has a disclosure policy.