REITs vs Physical Property: A Tax and Yield Comparison for Corporate Investors

For corporate treasurers, CFOs, and investment committees, deploying capital efficiently is a never-ending challenge. In an economic landscape defined by fluctuating interest rates and inflationary pressures, the search for resilient yield is paramount. Real estate has long been the cornerstone asset class for institutional-grade stability and income generation.

However, the “how” of real estate investing is just as critical as the “what.”

The traditional dichotomy—owning tangible bricks and mortar versus holding paper shares in real estate companies—presents a complex decision matrix for corporate entities. It is not merely a question of preference; it is a calculation based on liquidity needs, risk appetite, operational capacity, and, perhaps most critically, tax implications.

This is not a guide for the retail investor looking to park a few thousand dollars. This is a strategic deep dive into the trenches of REITs vs Physical Property: A Tax and Yield Comparison for Corporate Investors. We will strip away the generalizations to look at how these two distinct vehicles impact the corporate balance sheet and bottom line.

Understanding the Core Contenders from a Corporate Perspective

Before analyzing yield and tax, we must establish the fundamental structural differences between these two asset types when held within a corporate structure. The nature of the asset dictates its treatment by tax authorities and the market.

Defining Direct Physical Property Ownership

Direct ownership is exactly what it sounds like. Your corporation (or a special purpose subsidiary created for liability ring-fencing) holds the deed to a commercial asset an office building, an industrial warehouse, a multi-family complex, or retail center.

For a corporation, this means the asset sits on the balance sheet. The income derived is rental income, which is generally treated as active business income (depending on the level of management involvement). The corporation is solely responsible for asset management, leasing, maintenance, capital expenditures (CapEx), and eventual disposition. It provides total control but demands significant operational bandwidth.

Defining Real Estate Investment Trusts (REITs)

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Modelled after mutual funds, REITs pool the capital of numerous investors. Crucially, for a company to qualify as a REIT (in the US and many similar international jurisdictions), it must meet strict criteria, most notably the requirement to distribute at least 90% of its taxable income to shareholders annually in the form of dividends.

For a corporate investor, buying shares in a publicly traded REIT is purchasing a security, not a property deed. The asset on your balance sheet is equity stock. You have zero operational control over the underlying properties. You are essentially outsourcing the real estate expertise to the REIT’s management team and accepting a passive income stream in return.

The Corporate Context: Why This Isn’t Retail Investing

Why does the distinction between a corporate investor and an individual matter?

1. Tax Brackets: Corporations face a flat corporate tax rate (currently 21% at the federal level in the US), whereas individuals face progressive brackets.
2. Capital Scale: Corporations are often deploying millions, or tens of millions, making direct ownership of significant commercial assets feasible in a way it isn’t for most individuals.
3. Operational Mandate: A manufacturing company’s core competency is making widgets, not managing tenants. Direct property ownership can distract from the primary business mission if not managed correctly.

The Yield Battle: Income Generation Mechanisms

The primary attraction of real estate is yield—the regular income stream the asset generates. However, the source and stability of that yield differ vastly between REITs and physical assets.

Analyzing REIT Yields: The Dividend mandate

REITs are yield-generating machines by design. Because of the 90% distribution requirement mentioned earlier, they are often referred to as “pass-through” entities. They don’t pay corporate tax at the REIT level so long as they distribute their income.

The Yield Mechanic: The yield comes in the form of quarterly (sometimes monthly) dividend payments.

• Pros for Corporations: The yield is highly visible, predictable, and requires zero effort to collect. You can easily model future cash flows based on historical dividend payouts. Because REITs are usually large and diversified, the income stream is relatively stable even if one or two properties in their portfolio underperform.
• Cons for Corporations: The 90% payout rule means REITs retain very little capital for internal growth. To acquire new properties, they must either take on debt or issue new equity (diluting existing shareholders). Furthermore, because the yield is paid out as dividends, it is immediately taxable to the corporate investor in the year it is received. There is little room to defer that income.

Analyzing Physical Property Yields: Net Operating Income (NOI)

The yield from physical property is derived from Net Operating Income (NOI). This is the rental income remaining after all operating expenses (property taxes, insurance, maintenance, utilities, property management fees) have been paid—but before debt service and income taxes.

The Yield Mechanic: The “Cap Rate” (Capitalization Rate), calculated as NOI divided by the property’s purchase price, is the standard measure of unlevered yield.

• Pros for Corporations: The potential for yield enhancement is higher. A savvy corporate owner can aggressively manage expenses, renovate to increase rents, and force appreciation. You are in control of the NOI. Furthermore, the cash flow is technically corporate revenue, which can be offset by a variety of corporate expenses before net profit is calculated.
• Cons for Corporations: NOI is volatile. Vacancy is a real risk; an empty warehouse generates zero income while still incurring costs. Furthermore, “lumpy” capital expenditures—like replacing a roof or an HVAC system—can severely depress yield in any given year. The stated cap rate on paper often evaporates if management is poor.

Growth Potential: Appreciation vs. Reinvestment

Yield is income today; growth is income tomorrow.

• REIT Growth: Because they pay out most income, share price appreciation usually comes from the REIT’s ability to raise cheap capital to buy more properties, or from rising asset values across the sector. Growth is generally slower and steadier.
• Physical Growth: Corporations can realize massive appreciation through “value-add” strategies—buying distressed assets and fixing them. They also benefit directly from hyper-local market appreciation, which they can realize upon sale.

The Critical Deep Dive: Tax Implications for Corporate Investors

Disclaimer: The following information is for illustrative purposes regarding general corporate taxation principles, particularly framed around the US tax code as a baseline. Tax laws vary significantly by jurisdiction and are subject to change. Corporate investors must consult with qualified tax counsel regarding their specific situation.

This is where the comparison becomes most complex. The tax treatment of these two asset classes can dramatically alter the “after-tax return” profile for a corporation.

Taxation of REIT Dividends for Corporations

For individual investors, REIT taxation is complicated because dividends can be classified as ordinary income, capital gains, or return of capital.

For corporate investors, the picture is slightly different. Generally, REIT dividends received by a corporation are treated as ordinary income and are subject to the standard corporate tax rate.

Crucially, corporate investors usually cannot claim the Dividends Received Deduction (DRD) on typical REIT dividends. The DRD is designed to prevent triple taxation when one corporation pays dividends to another. However, because the REIT entity itself generally pays no corporate tax (due to the pass-through nature), the IRS does not allow the receiving corporation to deduct those dividends.

• The Tax Reality: REIT income is efficient at the source (the REIT level), but fully taxable at the corporate investor level immediately upon receipt.

Taxation of Physical Property Income

Income derived from direct property ownership is treated as corporate revenue. It flows into the company’s general P&L.

On the surface, this is taxable at the corporate rate. However, physical ownership offers a massive advantage: Deductibility.

Because the corporation owns the asset, it can deduct all operating expenses, interest payments on mortgages (subject to certain limits based on EBITDA), and property taxes. These deductions significantly shrink the taxable base of the rental income.

The Power of Depreciation: Physical Property’s “Phantom Expense”

This is perhaps the single biggest tax differentiator and the primary reason many corporations opt for direct ownership.

Depreciation is a non-cash expense that the tax code allows property owners to take annually to account for the theoretical “wear and tear” of the building over time (land is not depreciable).

• How it works: If a corporation buys a commercial building for $10 million (excluding land value), they can deduct a portion of that cost every year for notably 39 years (for commercial property in the US). That’s roughly $256,000 a year in “losses” they can paper against their rental income, even though no cash actually left the bank account for that expense in that year.
• The Result: A physical property might generate $300,000 in positive cash flow, but after applying depreciation, it might show little to no taxable income on the books. This allows the corporation to shelter significant amounts of current cash yield from current taxation.

Supercharging Depreciation with Cost Segregation

Sophisticated corporate investors use “Cost Segregation Studies.” Instead of depreciating the whole building over 39 years, engineers identify components that wear out faster—carpeting, lighting, HVAC, landscaping. These can be reclassified to much shorter depreciation schedules (e.g., 5, 7, or 15 years), sometimes allowing for “bonus depreciation” where huge chunks of the asset’s cost are deducted in year one. This creates massive upfront tax shields.

You cannot perform a cost segregation study on a REIT share.

The Capital Gains Conundrum

What happens when it’s time to sell?

• Selling REIT Shares: If a corporation holds REIT shares for longer than a year and sells at a profit, it realizes a corporate capital gain, taxed at the standard corporate rate. It’s a straightforward securities transaction.
• Selling Physical Property: Selling a building triggers capital gains tax and, crucially, depreciation recapture. The IRS essentially says, “Since we let you take those depreciation deductions over the years, we are now taxing that amount back at a specific rate (currently 25% for section 1250 property in the US) upon sale.”

While recapture sounds painful, the corporate investor has had the benefit of the time value of money—using that un-taxed cash flow for years before eventually paying the piper.

1031 Exchanges: The Physical Advantage

One final, massive advantage for direct ownership (in the US) is the Section 1031 Like-Kind Exchange. This allows an investor to sell a property and reinvest 100% of the proceeds into a new, similar property, deferring all capital gains and depreciation recapture taxes indefinitely.

A corporation can continually “trade up” properties, growing its asset base without ever triggering a taxable sale event until the final liquidation.

You cannot 1031 exchange out of REIT shares into another investment.

Beyond Tax and Yield: Other Crucial Corporate Considerations

While tax and yield are paramount, the operational realities of these investments cannot be ignored.

Liquidity and Speed of Execution

• REITs (High Liquidity): Publicly traded REITs offer near-instant liquidity. A corporate treasurer needing to raise cash can sell millions of dollars in REIT shares during market hours with a mouse click. The cost of entry and exit is minimal (brokerage commissions).
• Physical Property (Low Liquidity): Real estate is notoriously illiquid. Selling a commercial building is a process measured in months, involving brokers, due diligence, inspections, and financing contingencies. It is not a place to park cash that might be needed next quarter.

Management Overhead and Expertise

• REITs (Zero Overhead): The investment requires financial analysis expertise, but no real estate operational expertise. It is a “hands-off” investment.
• Physical Property (High Overhead): Direct ownership requires active asset management. The corporation needs an internal real estate team or must hire third-party property managers. Dealing with tenant disputes, lease negotiations, and emergency repairs is time-consuming and requires specialized knowledge. If the corporation’s core business isn’t real estate, this can be a significant distraction.

Diversification and Risk Mitigation

• REITs (Instant Diversification): A single REIT share gives you fractional ownership in potentially hundreds of properties across different geographies and sometimes different sectors (e.g., data centers, healthcare, logistics). To achieve the same level of diversification directly would require billions of dollars.
• Physical Property (Concentration Risk): Direct ownership is inherently concentrated. Buying one $20 million office building means your real estate fortune is tied entirely to the economic health of that specific city block and those specific tenants.

Strategic Scenarios: When to Choose Which

Given the stark differences in tax treatment, liquidity, and management requirements, when does each make sense for a corporate investor?

The Case for the REIT Route

The REIT route is generally superior for corporations that:

1. Prioritize Liquidity: Treasuries that need the ability to convert assets to cash quickly to fund core business operations or M&A activity.
2. Lack Internal Real Estate Expertise: Companies that do not want the operational burden or distraction of managing physical assets.
3. Seek Immediate Diversification: Investors wanting broad exposure to real estate sectors (like cell towers or data centers) that are difficult to buy directly.
4. Have Lower Tax Sensitivity: Perhaps the corporation has significant other tax losses to offset REIT income, making the lack of depreciation shelter less critical.

The Case for the Physical Property Route

Direct ownership is generally preferred by corporations that:

1. Have a Long-Term Capital Horizon: “Patient capital” that does not need to be accessed for 10+ years.
2. Need Significant Tax Shelters: highly profitable corporations looking to use depreciation and cost segregation to offset other corporate income and lower their effective tax rate.
3. Possess Operational Expertise: Companies with existing real estate departments or those in adjacent industries (e.g., construction, logistics) that can leverage their knowledge for better asset management.
4. Seek Strategic Control: Companies that want to own buildings they might eventually occupy themselves, or who want total control over the asset’s destiny.

Conclusion: REITs vs Physical Property

The debate between REITs versus physical property for corporate investors is not about declaring an ultimate victor. It is about aligning asset characteristics with corporate strategy.

REITs offer the democratization of real estate yield—providing liquidity, diversification, and operational simplicity, albeit with a less tax-efficient income stream for the corporate holder.

Physical property remains the heavyweight champion of tax deferral and long-term wealth compounding through tools like depreciation and 1031 exchanges, but it demands significant capital, patience, and operational expertise.

For the corporate investment committee, the decision rests on a clear-eyed assessment of their own internal capabilities, their tolerance for illiquidity, and their specific tax position. Often, the most sophisticated corporate portfolios don’t choose one or the other—they strategically utilize both to balance their need for current income, future growth, and tax efficiency.

FAQs