REIT vs. Real Estate Fund: An Overview

Real estate funds and real estate investment trusts (REITs) are used when diversifying a long-term investment portfolio. A real estate fund is a type of mutual fund that primarily focuses on investing in securities offered by public real estate companies. A REIT is a corporation, trust, or association that invests directly in income-producing real estate and is traded like a stock.

Key Takeaways

  • Real estate investment trusts are corporations that invest in income-producing real estate and are bought and sold like stocks.
  • Real estate funds are types of mutual funds that receive the same type of portfolio management support.
  • Many real estate funds invest in REITs.

REIT

A REIT's mode of operation 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. A REIT's taxable income is paid out as dividends to shareholders, who then pay income tax on the dividends.

There are three main types of REITs: equity REITs, mortgage REITs, and hybrid REITs. Equity REITs own, operate, and trade hard real estate assets. Mortgage REITs trade commercial and residential mortgages, and 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 interest through mortgage loans.

Investments in both REITs and real estate funds have their benefits and drawbacks. The benefits of investing in REITs include their lower investment entry costs, sometimes as little as $500 or the price of one share.

REITs offer a highly liquid method of investing in real estate and are highly flexible, offering investors real estate ranging from commercial properties to shopping malls.

Real Estate Fund

Real estate fund investments allow investors to reap the same benefits they would if they were investing in a mutual fund, as they receive the same professional and portfolio management support. Real estate fund investments with direct investments invest in assets and real estate funds that invest indirectly invest in REITs. The majority of real estate funds are invested in commercial and corporate properties, although they also may include investments in raw land, apartment complexes, and agricultural space.

Real estate funds gain value mostly through appreciation and generally do not provide short-term income to investors the same way that REITs might.

Advisor Insight

Rebecca Dawson
Silber Bennett Financial, Los Angeles, CA

A REIT is actually like a stock. It trades publicly on an exchange, and it must meet the SEC requirement that it distributes at least 90 percent of its taxable income to shareholders, which is why REITs appeal to income-oriented investors. In contrast, a private real estate fund is like a mutual fund. Since they don’t trade, they are pretty non-liquid. While they provide some income, their main aim is appreciation, realized when they sell their holdings.

Not to confuse the issue, but there are also private REITs. They pay monthly or quarterly distributions, have a stated redemption date and come with warrants attached to the company's common REIT stock. Since they don’t trade on the market, they are not as volatile as public REITs, and they also offer some appreciation potential via the warrants.