What Are the Pros and Cons of Owning an Equity REIT vs. a Mortgage REIT? (AEC, HOT)

There are several different types of real estate investment trusts (REITs) including equity REITs, mortgage REITs, and hybrid REITs.

Equity REITs invest in hard real estate assets. An example of an equity REIT is Senior Housing Properties Trust (SNH). Equity REITs generate income from rent on properties as well as by buying undervalued properties and selling them for a profit. Some equity REITs are diversified and invest in several different categories of real estate, such as retail spaces and apartments. The Kilroy Realty REIT (KRC) is an example of a diversified REIT. Other REITs focus on narrower segments of the real estate market, such as retail, as with the CBL & Associates Properties Inc. REIT (CBL), or hotels, such as Sotherly Hotels Inc. (SOHO).

A significant percentage of equity REIT profits are paid to investors as dividends. Equity REITs tend to perform better when interest rates are low, and property prices are rising. However, the intricacies of the different markets covered by equity REITs means that there are almost always opportunities available.

Mortgage REITs invest in mortgages only, and they make up less than 10% of the REIT market. An example of a mortgage REIT is the Apartment Investment and Management Company REIT (AIV). REITs such as AIV earn money by charging interest on money lent to borrowers to finance property purchases. They also trade and invest in mortgage-backed securities. There are commercial mortgage REITs, such as the Capstead Mortgage Corporation REIT (CMO), and residential mortgage REITs, such as the Anworth Mortgage Asset Corporation REIT (ANH). Some mixed REITs, such as Dynax Capital Inc. REIT (DX) invest in both commercial and residential REITs.

As with equity REITs, the majority of mortgage REIT profits are paid to investors as dividends. Mortgage REITs tend to perform better in times of rising interest rates. However, like equity REITs, there are so many different target markets that mortgage REITs almost always have investment opportunities available.

Hybrid REITs invest in both properties and mortgages. There are only a few REITs that actually engage in both types of business activity; the Two Harbours Investment Corp. REIT (TWO) is an example of one. Two Harbours invests in residential mortgage-backed securities, residential mortgage loans, and residential real properties and assets. By investing in both mortgages and hard assets, hybrids REITs, such as Two Harbours, take a more balanced approach and may be able to profit in both rising and falling interest rate environments where traditional equity only or mortgage only REITs can struggle.

The Two Harbours REIT has a market capitalization of $2.87 billion as of Nov. 17, 2016, and its current dividend yield is 11.06%.