Historically, REITs have delivered returns slightly below equities but often outperform traditional fixed income indexes.
Investors typically receive higher income from REITs than from a broad equity index like the S&P 500, though growth potential remains more modest.
These high dividends create a steady income stream that complements bonds in a portfolio.
Real Estate Investment Trusts (REITs) open the door for investors to participate in the real estate market through a liquid, accessible portfolio. By investing in REITs, you can tap into current income streams that often adjust with inflation, benefit from potential appreciation as property values rise, and add meaningful diversification to your traditional stock and bond holdings. Understanding REITs’ unique return drivers and risks can help determine if they fit your investment strategy and personal circumstances.
REITs offer investors a compelling mix of income, price appreciation and diversification.
What are REITs?
REITs operate as corporations registered with the Securities and Exchange Commission, owning and managing real estate-related assets. Their management teams actively shape corporate strategy, oversee property acquisition and disposition, and make financing decisions. Unlike developers who build properties for resale, REITs typically hold and operate properties as part of their investment portfolios.
To qualify as a REIT, a company must meet strict requirements:
- At least 75% of assets must be real property or related loans.
- 75% of gross annual income must come from real estate sources.
- REITs must pass through 90% of corporate income as dividends.
For instance, if you invest in a REIT focused on healthcare, you’re indirectly owning a piece of hospitals and senior living facilities, and you receive a share of the rental income those properties generate. REITs cover a wide spectrum of property types, including healthcare facilities, industrial sits, single- and multi-family residential housing, retail spaces, offices, hotels, and data centers.
REIT investment considerations
Historically, REITs have delivered returns slightly below equities but often outperform traditional fixed income indexes. Investors typically receive higher income from REITs than from a broad equity index like the S&P 500, though growth potential remains more modest. These high dividends create a steady income stream that complements bonds in a portfolio. As lease revenues increase, property values may appreciate further enhancing returns.
While REIT return characteristics resemble stocks and bonds, exposure to real estate can help diversify portfolios. Broad economic conditions can influence leases and property values, providing portfolios with important links to growth and inflation. Over the last decade, REITs have shown a 0.75 correlation with stock prices and 0.50 correlation with bond returns. A positive correlation indicates REIT returns tend to move together with stocks and bond prices. However, a value below one means the correlation is imperfect, REITs offers valuable diversification benefits.
REIT market structure and diversification
Broad REIT indexes include a variety of real estate types, each with distinct characteristics. The largest sub-industries, healthcare, retail, industrial, and telecommunication-related companies, make up about half of the U.S. REIT market. Other REITs focus on residential properties, data centers, self-storage, offices, and hotels.
By allocating across these property types, you gain exposure to factors like demographic shifts, consumer spending, supply chain changes, and technological advancements. For example, if you invest in a REIT exchange traded fund, you might own a slice of everything from warehouses supporting e-commerce to data centers powering artificial intelligence and cloud computing. Geographic diversification also plays a role, as real estate conditions vary based on location.
The fundamentals behind real estate opportunities
Several fundamental factors shape opportunities in REITs, including income growth, property supply and demand, and borrowing costs. While fundamentals differ across property types, the largest categories currently exhibit healthy income growth, modest inventory expansion, and strong or improving occupancy rates. Borrowing costs rose in 2022 and 2023, challenging both developers and investors, but debt costs since eased.
Net operating income (NOI) serves as a key fundamental metric, measuring real estate earnings after subtracting normal operating costs. Investors evaluate REITs using NOI because it focuses on core real estate drivers such as generating and growing rental income while incurring regular property management expenses. Historically, broad REIT allocations have generated 2.9% annual NOI growth, closely tracking economic trends. Recent years have seen stable NOI growth, while the largest property types outperformed the average. Remote work trends have negatively impacted office real estate NOI, but the category represents less than 5% of the REIT market.
Future income growth for REITs often depends on tenant demand and real estate supply. Occupancy rates, which measure the share of leased space generating income, provide insight into rent growth potential. Industrial, retail, and apartment currently boast occupancy rates above 94%, indicating robust demand. Office properties have struggled to find tenants and lag behind with just 85% occupancy, near the lowest level over the last two decades.
Slow real estate inventory growth can also contribute to high occupancy rates. Real estate inventory refers to the total supply of leasable property. Real estate inventory growth slowed from 2022 through 2025 as higher borrowing rates, material price increases, and constrained labor supply increased property development costs. The residential housing market presents an example of high borrowing costs influencing supply. Housing market activity slowed as mortgage rates increased in 2022 and 2023. Low inventory supported home prices across much of the U.S., and many prospective homeowners continue to rent in response challenging home affordability. Modest inventory growth across both residential and commercial real estate in recent years supports prices of existing properties.
REITs typically borrow against their properties, making commercial mortgage costs a significant factor on REIT fundamentals. Like consumer mortgages, as bond yields fluctuate, so do REIT borrowing costs. Recent Federal Reserve (Fed) interest rate cuts in 2024 and 2025 have provided a tailwind for REITs.
Since the global financial crisis (GFC) of 2008, REITs have reduced their debt levels, now averaging 32% of asset value over the last ten years, compared to over 40% in the five years leading up to the GFC. Lower debt improves resilience during economic downturns, though it may limit profitability during periods of growth.
While pockets of the real estate market like office properties still face headwinds from low occupancy rates and stagnant NOI growth, broader real estate market fundamentals remain sound. Diversified exposures to REITs that span property types continue to generate positive income growth, with strong occupancy rates, manageable debt levels, and can benefit from stable, to potentially lower, borrowing costs ahead.
REITs generate substantial income, but face competition from bonds
Investors often compare NOI to property values to measure the annual income yield from REITs, called a capitalization rate (cap rate). Broad REIT allocations currently offer a 5.6% cap rate, close to the 20-year average of 6.1%. This suggests that REITs are generating fair and substantial income for investors, when compared to their historical value. Office properties have higher cap rates, compensating investors for weaker fundamentals, while lower-risk categories like health care and industrial properties show slightly lower rates, around 4.6% and 4.8% respectively.
Despite fair and substantial cap rates, investors currently pay somewhat elevated prices for REITs compared with bond income opportunities. REIT cap rates are currently 1.5% above 10-year U.S. Treasury yields, meaning investors can expect to generate roughly 1.5% additional income from REITs over U.S. government debt. Although REITs provide a premium over 10-year Treasury yields, this spread is narrower than the historical average. of 3.2% over the last 20 years. Much like other assets, REIT valuations can remain elevated for long periods, and REITs still present reasonable return opportunities as income grows over time.
Current considerations for REIT investors
Investing broadly across REIT exposures allows you to balance opportunities and risks across property types. Current office real estate challenges, surging data center demand, and long-term demographic tailwinds for healthcare real estate provide examples of the different factors influencing individual real estate categories.
The rise of remote work during the COVID pandemic in 2020 challenged office properties as companies reduced their real estate footprint. The office real estate market remains slow with weak fundamentals. Lease income fell, occupancy rates remain low, and buildings have sold at steep discounts to prior valuations. While headwinds for office real estate persist, opportunities can still emerge in specific properties as valuations across the categories reset to cheaper levels and demand for high-quality buildings persists.
In contrast to office, datacenters experienced a surge in demand as companies sought to build out artificial intelligence (AI) capabilities. Datacenter valuations adjusted higher to reflect the strong fundamentals in the category; cap rates fell, and property values appreciated. Individual datacenters can still face diverging impacts as newer technology displaces older computing systems, and datacenter REIT prices can change with investor expectations for AI, resulting in an evolving opportunity set.
Healthcare real estate spans senior housing, various types of assisted care, and medical facilities like clinics and hospitals. While the category captures many types of properties, all share the common tailwind from an aging population with growing healthcare needs. Healthcare properties are now the largest category of U.S. REITs and have lower cap rates compared other large REIT segments like industrial, retail, and residential REITs to recognize the long-term demographic trends supporting health care demand.
How to invest in REITs
You can invest in REITs by purchasing publicly traded companies on an exchange, like buying individual stocks. Alternatively, you may choose ETFs or mutual funds that hold diversified REIT portfolios. Private capital vehicles also exist, targeting specific strategies such as office market dislocations or value-add multifamily opportunities in undersupplied markets.
REITs offer investors compelling mix of income, price appreciation and diversification. U.S. Bank’s Asset Management Group views modest allocations to REITs and real estate as important contributors to a diversified investment portfolio. Speak with a wealth advisor to learn more and determine if REITs have a place in your portfolio.
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