The riddle
What Do the Letter T and an Island Have in Common?
Look inside the word water
Spell the last word of the answer: w, a, t, e, r. Five letters, and the one in the middle is the T. An island is land with water all around it, so it also sits in the middle of water. The riddle is built on that echo between a letter and a place. The question sounds as though the two things share some quality, and the answer shows that they share a position.
The same riddle in 1915
Edith B. Ordway printed the riddle in The Handbook of Conundrums in 1915, worded as a "why" question: "Why is an island like the letter T?" Her answer is "Because it is in the midst of water (wa-t-er)." J. Gilchrist Lawson printed it again in 1924, without the spelling in brackets.
Middles of other words
Any word with an odd number of letters has a middle letter, and that makes a good follow-up game. The middle of ocean is the E. The middle of river is the V. Ask the group to name a body of water and say what letter sits in its center, and see who spots that sea has an E in the middle, too.
Best on paper
Said aloud, the answer hides the T, because nobody hears the spelling of "water". Writing the word on a card, or spelling it out letter by letter, makes the joke land.