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CFA Level II Exam · Investments in Real Estate through Publicly Traded Securities

REITs and REOCs: Structure and Types

Updated 7 October 2026 · Fact-checked

A REIT is a tax-advantaged real estate company or trust that must hold mostly real estate assets, earn mostly real estate income and distribute most taxable income. A REOC is an ordinary taxable real estate operating company. Solve questions by identifying the asset type, tax status and distribution policy in the vignette.

Understand REITs and REOCs: Structure and Types

A REIT (real estate investment trust) is a vehicle that owns income-producing real estate, or loans secured by it, and lists its shares on an exchange. It lets you hold real estate with the liquidity of a stock. Rules differ by country, but the common design is the same.

The key feature is tax treatment. A REIT that meets the tests generally pays little or no corporate income tax on income it distributes. In exchange, it must meet conditions. Typical conditions are: most assets in real estate, most income from real estate (rents or mortgage interest), a minimum payout of taxable income, and often a widely held shareholder base with limits on concentrated ownership. Exact thresholds vary by country, so rely on the numbers given in the question.

The tax benefit avoids double taxation. An ordinary company pays tax on profit, then shareholders pay tax on dividends. A REIT is taxed mainly at the investor level. Because of the high payout, REITs retain little cash and depend on capital markets to fund growth. That makes them sensitive to interest rates and credit conditions.

There are two main types. Equity REITs own and operate properties and earn rental income. Returns depend on rents, occupancy and property values. Mortgage REITs (mREITs) hold mortgages or mortgage securities and earn interest. They are often leveraged and sensitive to interest rates and credit risk. Hybrid REITs hold both. Equity REITs are also grouped by property sector, such as retail, office, residential, industrial and healthcare.

A REOC (real estate operating company) is an ordinary taxable company in real estate. It can develop, trade and hold properties, invest in non-real-estate activities, and retain earnings. It has no payout requirement and no special tax status. Compared with a REIT, a REOC has more operating flexibility and growth capacity, but it pays corporate tax and usually pays lower dividends. Investors who want stable income prefer REITs. Investors who want growth and development exposure may prefer REOCs.

Key formulas to remember

REIT qualification tests (typical)
Assets mostly real estate + income mostly real estate + minimum payout of taxable income + widely held
Thresholds differ by country. Use the figures stated in the vignette.
Equity REIT income
Rental income from owned properties
Driven by rents, occupancy and property values.
Mortgage REIT income
Interest income on mortgages and mortgage securities
Driven by interest spreads, leverage and credit quality.
REIT vs REOC tax
REIT: little tax at entity level on distributed income. REOC: corporate tax on profits
Investors are taxed on distributions from both.

How to solve REITs and REOCs: Structure and Types questions

Use this approach for any REIT or REOC question in an item set.

  1. 1Identify the entity: look for words such as trust, distribution requirement, tax status, development or trading.
  2. 2Classify the assets: owned properties point to equity REIT, mortgage loans or securities to mortgage REIT, a mix to hybrid.
  3. 3Check the qualification tests in the exhibit: asset test, income test, payout test and ownership test. Compare each with the stated threshold.
  4. 4Decide the tax result: a qualifying REIT is taxed little on distributed income. A REOC pays corporate tax.
  5. 5Link structure to behavior: high payout means limited retained cash and reliance on external funding. REOCs can retain earnings and develop.
  6. 6Pick the answer that matches the key risk driver: rents and occupancy for equity REITs, interest rates and credit for mortgage REITs.

Quickest way: Three-question screen

When to use it: When time is short and the question asks you to classify or compare entities.

  1. Does it own property or loans? Property means equity REIT, loans means mortgage REIT.
  2. Is there a payout requirement and tax exemption on distributions? Yes means REIT, no means REOC.
  3. Does it develop, trade or hold non-real-estate activities and retain earnings? That points to a REOC.

Common mistakes in REITs and REOCs: Structure and Types

  • Treating a REOC as tax-exempt.

    Both hold real estate, so students assume the same tax status.

    Fix: Only entities meeting the REIT tests get the tax benefit. A REOC is an ordinary taxable company.

  • Saying REITs avoid all taxes.

    The tax advantage is overstated in summaries.

    Fix: Say little or no entity-level tax on distributed income. Investors still pay tax on distributions.

  • Confusing mortgage REIT risks with equity REIT risks.

    Both are called REITs.

    Fix: Equity REITs depend on rents and property values. Mortgage REITs depend on interest spreads, leverage and credit.

  • Memorizing one country's thresholds as universal.

    Rules appear as fixed numbers in notes.

    Fix: Treat thresholds as country-specific and use the numbers in the vignette.

  • Assuming REITs retain earnings to grow like REOCs.

    Ignoring the payout requirement.

    Fix: A high payout leaves little retained cash, so REITs rely on debt and equity issuance for growth.

Worked examples

Example 1

Vignette: Harbor Trust is a listed entity that owns office buildings and distributes nearly all taxable income to meet its tax status. Delta Properties is a listed company that develops and sells residential projects, retains most earnings and pays normal corporate tax. Q1: Classify each entity. Q2: Which has more flexibility to fund growth internally?

Show the solution
  1. Harbor owns properties and has a distribution requirement tied to tax status, so it is an equity REIT.
  2. Delta develops and sells, retains earnings and pays corporate tax, so it is a REOC.
  3. Retained earnings fund internal growth. Delta retains most earnings. Harbor distributes nearly all.

Answer: Harbor Trust is an equity REIT and Delta Properties is a REOC. Delta has more flexibility to fund growth internally.

Example 2

Vignette: Crest Capital is a listed REIT whose assets are mainly residential mortgage securities funded with short-term borrowing. Its income is interest received less funding cost. Q1: What type of REIT is it? Q2: What is its main risk driver?

Show the solution
  1. Assets are mortgage securities and income is interest, so it is a mortgage REIT.
  2. Income depends on the spread between asset yield and funding cost, and it is leveraged.
  3. Main risks are interest rate changes and credit quality, not rents or occupancy.

Answer: Crest Capital is a mortgage REIT. Its main risk drivers are interest rate movements, funding cost, leverage and credit risk.

Exam tips

  • Expect classification questions: give the asset and income source, then pick equity, mortgage or hybrid.
  • When comparing REIT and REOC, anchor on tax status and payout. These decide most answer choices.
  • Never use a remembered threshold if the vignette gives one. Test the exhibit numbers against the rule.
  • Link structure to valuation: stable payout suits income-based measures like FFO, while REOCs suit earnings-based approaches.

REITs and REOCs: Structure and Types in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

REITs and REOCs: Structure and Types: frequently asked questions

What is the main difference between a REIT and a REOC?

A REIT meets asset, income and payout tests and so pays little entity-level tax on distributed income. A REOC is an ordinary taxable company with no payout requirement. A REOC can retain earnings and take on development or non-real-estate activity.

What is the difference between equity and mortgage REITs?

Equity REITs own properties and earn rent. Mortgage REITs hold loans or mortgage securities and earn interest. Mortgage REITs are typically more sensitive to interest rates and credit risk.

Why do REITs pay high dividends?

To keep their tax status they must distribute a large share of taxable income. This also means they retain little cash and rely on external capital to grow.

Do I need to memorize REIT thresholds for the exam?

Rules vary by country, so know the types of tests rather than exact numbers. The vignette will normally give any thresholds you need.