REITs vs. Real Estate Mutual Funds: An Overview

REITs (REITs) and mutual funds for real estate provide the possibility of diversification and an affordable, accessible option for investors looking to invest in different areas in the market for real estate. They are also an investment vehicle more liquid for support in this area than having the property or purchasing the tangible property directly.

There’s a broad selection of REITs and mutual funds that focus on the real estate industry to pick from. Before you decide to invest in either instrument, you must be aware of the main differences and their advantages and disadvantages.

KEY TAKEAWAYS

• The investment in real estate assets will help diversify portfolios and improve yields.
• REITs are shares-like securities that give investors access to debt or equity-based real estate portfolios. REITs generally invest directly into mortgages or properties.
• REITs can be classified as mortgage, equity, or hybrid.
• Mutual funds for real estate are managed by a fund manager who invests in REIT stocks, real estate stocks, indexes, or both.
• REITs are generally more tax-efficient and less expensive than mutual funds for real estate.

REITs

A REIT is a type of corporation or trust that invests directly in real estate by purchasing mortgages or properties. They trade on stock exchanges and are sold as stocks. REITs distribute dividends in their structures. REITs are required by the Internal Revenue Service (IRS) to pay the majority of their taxable profits (90 or more) to shareholders in dividends. REIT firms, however, are not required to have to pay tax on corporate income. 1

At least 75% of a REIT’s assets must come from real estate, and at a minimum, 75percent of the net earnings must come from mortgage interest, rents, or gains from the selling or lease of property. 1

The three main kinds include equity REITs, mortgage REITs, and hybrid REITs. 2

Equity REITs

Equity REITs are investors and own in real estate, including offices, apartments, shopping malls, and hotels. They earn their money mainly by renting properties in which they own or have shares.

An equity REIT could invest across a wide range of sectors but could also concentrate on a specific area like hotels, warehouses, residential properties, hospitals, etc.

They generally generate steady income. Because they generate revenue by taking rent, their income is comparatively simple to forecast and tends to rise over time.

Most REITs are an equity-based kind. 3

Mortgage REITs

Mortgage REITs (or mREITs) invest in commercial and residential mortgages. These REITs lend money to mortgages or buy existing mortgages or mortgage-backed securities (MBS). While equity REITs usually generate revenues via rent, Mortgage REITs generate income through the payment of interest on their investment in debt.

Mortgage REITs typically perform better than equity REITs if the interest rates increase.

Hybrid REITs

Hybrid REITs are a mix of mortgage REITs and equity. They also own property col, lect rent, and invest in mortgage-related securities. Investing in hard and mortgage assets such as hybrid REITs like Two Harbors takes a more well-balanced approach. It could be successful from both falling and rising interest rates, where traditional equity-only or mortgage-only REITs may struggle.

There are only a handful of REITs that are hybrid-listed.

REIT Performance

REITs typically perform better when interest rates decline, and rents increase. Since they are dividend-paying stocks, REITs are scrutinized similarly to other stores. However, there are significant distinctions due to the accounting method used to evaluate the property. Since REITs are a type of company that buys property, as an example, it is possible to see more debt than other kinds of firms.

Capital market conditions are crucial, including the demand from institutions for REIT equity. In the short term, this demand could overpower the fundamentals. For instance, REIT stocks performed exceptionally well in 2001 and into the second half of 2002 despite the weak fundamentals, as the money flowed into every sector.

At the level of individual REITs, you should see positive growth prospects in revenue, like rentals, associated service revenue, and FFO. It would help if you determined whether it is the case that a REIT has a distinct approach to increasing the occupancy of its properties and rising rents.

The industry sector is also crucial because specialized REITs will have yields that are different based on the type of properties in their possession. For example, the graph below shows REIT’s returns for each sector in 2019. In the reported year, industrial properties and data centers were most profitable, whereas retail and self-storage sank.