REITs vs. REIT ETFs: An Overview

Real estate investment trusts (REITs) are companies that own and operate real estate to produce and generate income. Investors can purchase shares in REITs—which represent ownership of an individual real estate company—just like regular stocks. The individual performance of REITs can vary widely. Many REITs are traded on major stock exchanges, but there are also a number of private and non-publicly traded REITs.

REIT exchange-traded funds (ETFs), on the other hand, invest their assets primarily in equity REIT securities and other derivatives. They often have low expense ratios and passively track indexes for the larger real estate market. These REIT indexes include a number of different types of REITs as components. By tracking an index, an investor can gain exposure to the larger real estate sector without having to risk capital on one individual company.

More sophisticated real estate investors may wish to invest in a single REIT. The investor may want to focus on a REIT with good management, a strong business plan or a focus on a certain portion of the real estate sector. But for any investor who does not want to perform due diligence on a number of different REITs, REIT ETFs may provide an easy way to gain diversified exposure to real estate in one trade.

Key Takeaways

  • Real estate investment trusts are companies that own and operate real estate to produce and generate income.
  • REIT exchange-traded funds invest their assets primarily in equity REIT securities and other derivatives. 
  • There are three different kinds of REITs: Equity REITs, mortgage REITs, and hybrid REITs.
  • REITs don't have to pay income taxes as long as they comply with certain federal regulations.
  • REIT ETFs are passively managed around indexes of publicly-traded owners of real estate.

REITs

As noted above, REITs own and operate real estate properties to produce and generate income, and offer shares on the public and private market to investors. There are three main types of REITs: Equity REITs, mortgage REITs, and hybrid REITs. Each brings a different scope to the table—from investment base to risk. Investors need to weigh out their investment goals before they decide to put their money into any one of these REITs.

Equity REITs

Nearly 90% of all REITs are equity REITs. Real estate investment trusts in this category own or invest directly in real estate properties that are income-producing. This means the revenue they generate comes directly in the form of rental income earned from those properties. Properties range from shopping centers, apartment and condominium buildings, corporate office spaces, health care homes, and even storage spaces. According to reit.com, more than $2 trillion in real estate assets are owned by equity REITs.

These REITs are required to pay out a minimum of 90% of their income to shareholders in the form of dividends.

Equity REITs must pay shareholders a minimum of 90% of their income in the form of dividends.

Mortgage REITs

Mortgage REITs invest in property mortgages. Some mREITs, as they are commonly called, may buy mortgage-backed securities (MBS)—both residential or commercial MBSs. Others buy or originate mortgage offerings to borrowers and property owners. These REITs make money from the interest from price appreciation in the value of the MBS or from the interest collected from mortgage loans.

These REITs provide investors with access to the mortgage market, while giving them the liquidity and transparency of the public equities.

Hybrid REITs

These types of REITs comprise the smallest percentage of the REIT sector. They are a combination of equity and mortgage REITs. They invest directly in both properties and mortgage loans. By investing in hybrid REITs, investors get the benefit of both equity and mortgage REITs in one asset. Although they may invest in both physical real estate and mortgages/MBSs, they are usually weighted more heavily in one over the other.

Investing in hybrid REITs comes with very low volatility and regular income that comes from property appreciation and dividend payouts.

Tax Advantages of REITS

REITs do not have to pay income taxes if they comply with certain federal regulations. REITs must distribute at least 90% of their taxable income annually to shareholders as dividends and distributions. At least 75% of the REITs’ assets must be in real estate, cash, or U.S. Treasuries, with at least 75% of the income coming from rents, mortgages, or other real estate investments. REIT shares must be held by a minimum of 100 stockholders.

REIT ETFs

REIT ETFs invest the majority of their funds in equity REITs and other related securities. As noted above, these investments are passively managed around indexes of publicly-traded owners of real estate. They are generally known for and favored by investors because of their high dividend yields.

REIT ETFs resemble both equities and fixed income securities, providing very consistent income for investors. These kinds of assets must pay out the majority of their income and profits to shareholders on an annual basis.

Examples of REITs and REIT ETFs

REITs

American Tower REIT (AMT) is one of the largest REITs in the world by market capitalization, which was $91.77 billion as of November 2019. Launched in 2012, it manages more than 170,000 multitenant communications real estate. Put simply, the company owns and operates broadcast and wireless communications equipment and infrastructure around the world. The REIT reported a 9.4% increase in revenue for the third quarter of 2019 to $1.95 million, as well as an increase in net income by 34% from the same period in 2018 to $505 million. As of Nov. 5, 2019, the REIT was trading at about $205 per share, and offered a dividend yield of 1.8%.

Simon Property Group (SPG) is one of the largest REITs by revenue in the United States. It owns and operates retail properties across North America, Europe and Asia including shopping centers and premium outlets. Simon was trading at about $157 as of Nov. 5, 2019, with a market cap of $48.5 billion. Simon offered a dividend yield of 5.31%. For the third quarter of 2019, SPG reported total revenue of $1.4 billion, an increase from $1.38 billion from the same period in 2018. Consolidated net income dropped from $631,414 in the third quarter of 2018 to $572,102 to Q3-2019.

REIT ETFs

The Vanguard REIT ETF (VNQ) is the one of the largest REITs in the sector and began trading in 2004. It invests in stocks issued by REITs and seeks to track the MSCI U.S. REIT index, the most prominent REIT index. VNQ had over 69.3 billion in assets under management (AUM) as of Sept. 30, 2019, with a very low expense ratio of 0.12%. It pays an attractive dividend of over 4%. The fund has 183 stocks in its holdings. The top 10 largest comprised 42.3% of the fund’s net assets. Specialized REITs had the largest allocation of holdings at 33.2%, with 14.9% of the fund's holdings in residential REITs and 12.5% in retail REITs. VNQ returned 9.57% for the three years prior to 2019, and was up 9.19% since its inception in September 2004.

The iShares U.S. Real Estate ETF (IYR) is another large REIT ETF. IYR tracks the Dow Jones U.S. Real Estate Index. It began trading in 2000 and had $4.8 billion in management as of Nov. 4, 2019. IYR has an expense ratio of 0.42%, which is higher than that of VNQ. The fund had 114 components and paid a dividend yield of 2.59% in as of Sept. 30, 2019. Shares of IYR returned 8.89% over the three years prior to 2019 and returned 10.06% since inception. IYR's shares trade on the New York Stock Exchange (NYSE).