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REITs vs. Real Estate Funds: An Overview
A REIT is a corporation, trust, or association that invests directly in income-producing real estate and is traded like a stock. A real estate fund is a type of mutual fund that primarily focuses on investing in securities offered by public real estate companies. While you can use either to diversify your investment portfolio, there are key differences to know.
Key Takeaways
- A real estate investment trust (REIT) is a corporation that invests in income-producing real estate and is bought and sold like a stock.
- A real estate fund is a type of mutual fund that invests in securities offered by public real estate companies, including REITs.
- REITs pay out regular dividends, while real estate funds provide value through appreciation.
REITs
A REIT‘s structure is similar to that of a mutual fund in that investors combine their capital to buy a share of commercial real estate and then earn income from their shares—but with some key differences. REITs are required to pay a minimum of 90% of taxable income in the form of shareholder dividends each year. This makes it possible for individual investors to earn income from real estate—without having to buy, manage, or finance any properties themselves.
There are three main types of REITs:
- Equity REITs own and operate income-producing real estate.
- Mortgage REITs lend money to real estate owners and operators either directly through mortgages and loans, or indirectly by acquiring mortgage-backed securities.
- Hybrid REITs are a combination of equity and mortgage REITs.
The majority of revenue associated with equity REITs comes from real estate property rent, while the revenue associated with mortgage REITs is generated from the interest earned on mortgage loans.
REIT portfolios may include apartment complexes, data centers, healthcare facilities, hotels, infrastructure, office buildings, retail centers, self-storage, timberland, and warehouses. As an example, here’s a breakdown of the top-performing sectors for 2019, according to the National Association of Real Estate Investment Trusts:
| Property Sector | Total Return in 2019 |
|---|---|
| Industrial | 48.7% |
| Data Centers | 44.2% |
| Timber | 42.0% |
| Infrastructure | 42.0% |
Real Estate Funds
Like regular mutual funds, real estate mutual funds can be either actively or passively managed. Those that are passively managed typically track the performance of a benchmark index. For example, the Vanguard Real Estate Index Fund (VGSLX), which invests in REITs that buy office buildings, hotels, and other properties, tracks the MSCI US Investable Market Real Estate 25/50 Index.
There are three types of real estate funds:
- Real estate exchange traded funds own the shares of real estate corporations and REITs. Like other ETFs, these trade like stocks on major exchanges.
- Real estate mutual funds can be open- or closed-end and either actively or passively managed.
- Private real estate investment funds are professionally managed funds that invest directly in real estate properties. These are available only to accredited, high-net-worth investors and typically require a large minimum investment.
Real estate funds invest primarily in REITs and real estate operating companies; however, some real estate funds invest directly in properties. Real estate funds gain value mostly through appreciation and generally do not provide short-term income to investors the same way that REITs might. Still, real estate funds can offer a much broader asset selection (and diversification) than buying individual REITs.
REITs vs. Real Estate Mutual Funds
Here’s a look at the key differences between REITs and real estate funds:
- REITs invest directly in real estate and own, operate, or finance income-producing properties. Real estate funds typically invest in REITs and real estate-related stocks.
- REITs trade on major exchanges the same way stocks do, and their prices fluctuate throughout the trading session. Most REITs are very liquid and trade under substantial volume. Real estate funds don’t trade like stocks and share prices are updated only once a day. You can buy a real estate fund directly from the company that created it or through an online brokerage.
- 90% of a REIT’s taxable income is paid out as dividends to shareholders, and those dividends are where investors make their money. Real estate funds provide value through appreciation, so they may not be a good choice if you want passive income or short-term profit.
Are REITs Appropriate for Long-Term Investors?
REITs must pay out much of their profits to shareholders as dividends, which makes them a good source of income, as opposed to capital gains. As such, they are more appropriate for investors looking for income. Long-term investors seeking appreciation who want exposure to real estate may want to instead consider mutual funds that specialize in this asset class.
Which Is More Liquid: REITs or Real Estate Funds?
Since REITs are listed and traded on major stock exchanges, they tend to be more liquid than mutual fund shares, which can only be redeemed at the end of the trading day when the NAV is settled.
Can You Short the Housing Market with REITs?
You can sell short a REIT the same as any other stock, so long as there are available shares to borrow. Note, however, that since REITs pay regular and relatively high dividends, the short is responsible for delivering that payment to the long. A better idea may be to short individual homebuilder stocks or housing ETFs to avoid this issue.
The Bottom Line
REITs and real estate mutual funds offer investors a way to access real estate without the need to own, operate, or finance properties. In general, REITs can provide a steady source of income through dividends. Real estate funds, on the other hand, create much of their value through appreciation, which makes them attractive to longer-term investors.