What is the difference between a REIT and a real estate fund?
Both 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. The majority of real estate funds are invested in commercial and corporate properties, although they also may include investments in raw land, apartments complexes and agricultural space. This type of fund can invest in properties directly or indirectly through REITs.
How REITs Work
A REIT is a corporation, trust or association that owns or finances income-producing real estate. Their mode of operation is similar to that of a mutual fund where investors combine their capital to buy a share of commercial real estate and then earn income from their shares. REITs’ taxable income is paid out as dividends to their shareholders, who then pay income tax on the dividends.
Types of REITs
There are three main types or 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. 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.
Pros and Cons
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 in that investors can invest as little as $500 or the price of one share. Secondly, REITs offer a highly liquid method of investing in real estate. Thirdly, REITs are highly flexible, allowing investors to invest in a range of real estate from commercial properties to shopping malls.
Real estate funds that invest in mortgage REITs provide higher yields than real estate funds that invest in equity REITs. Conversely, as equity REITs trade on assets and not on mortgage loans, capital gains are instead far more attainable for equity REITs.
Mortgage REITs don’t offer as much capital gains as equity REITs because an earned capital profit cannot be attained on a loan. Mortgage REITs’ potential for capital gains are correlated against interest rates, as the higher the interest rate, the greater the gain. Conversely, the opposite also applies. If mortgage rates fall, the REIT receives diminished interest payments and thus suffers a loss of expected income.
As REITs generally deliver more of an income, neither provides long-term capital appreciation. On the other hand, real estate funds that are not invested in REITs can offer capital appreciation and fund value appreciation.
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 real estate investments invest in assets, while real estate funds invest indirectly invest in REITs. An investor is, however, able to choose whether to invest in a real estate fund (that may or may not invest in REITs) or invest in REITs directly.
A REIT is a Real Estate Investment Trust that may be either a common or preferred stock that trades publicly on the stock exchange. Publicly traded REITs must meet stock exchange requirements that they trade on and make disclosures to the SEC. To qualify as a REIT, one of the requirements is that they must distribute at least 90% of taxable income to shareholders which is why they make such attractive income investments. The fact that they are publicly traded makes them much more liquid than a private real estate fund. REITs pay a high level of distribution and most REITs focus on large properties in their sector and geography of expertise. A preferred REIT is not as volatile as the common although you may get a higher dividend on the common stock of the same REIT.
Whereas, a private real estate fund is an investment in the fund's assets. The fund manager's income comes from their carried interest. Carried interest in finance is a share of the profits of an investment paid to the investment manager in excess of the amount that the manager contributes to the partnership. A performance fee rewarding the manager for enhancing performance. Private real estate funds may also buy different types of properties sometimes using leverage which creates the opportunity to enhance their returns. Most pay distributions and are non liquid with an expected exit strategy designed a higher total return for investors. These type of funds may invest in multifamily housing including student and senior housing, office properties, senior mortgage loan mezzanine debt, or grocery store anchor retail centers.
There are also private REITs that pay monthly or quarterly distributions, have a stated redemption date, and some with attached warrants to the company's publicly traded common REIT. These can be attractive since they do not trade with the market so they are not as volatile, pay income, have redemption options, and have upside potential with the attached warrants to the common.
REITs can come in different investment vehicles, and most real estate funds will be invested in a variety of publically traded REITs in some way.
Another type of REIT is what is known as a “non-traded” REIT. These are entities that pool money from investors to invest in similar ways to REITs that are traded on stock exchanges. The main difference however is these are private investment pools.
Non-traded REITs vary much more significantly as an investment vehicle from those found in real estate mutual funds or exchange-traded funds (ETFs). They typically lack liquidity provisions (you are in it until the fund dissolves, unless you can find a buyer but this is not often wise!), are more concentrated in how they invest (they may only invest in commercial, student housing, or mortgages).
Some of these REITs have gotten into trouble in recent years, as regulations have required more disclosure on the actual worth of the properties and relationships between the investors and the management of the REIT.
If you are considering an investment in a non-traded, private REIT t is important to do your homework. Since many of these partnerships also manage real estate for institutional investors, it is important to know how they determine when they are working for you – the retail investor – or other larger investors.
A real estate fund is a type of mutual fund that primarily focuses on investing in securities offered by public real estate companies. ... This type of fund can invest in properties directly or indirectly through REITs. A REIT is a corporation, trust or association that owns or finances income-producing real estate.
One thing that should be considered is the tax advantage of REITs. Many REITS provide significant income that is not taxable due to depreciation of the properties. Of course that depreciation will be recaptured upon the sale of the REIT.
The information, data, analyses and opinions contained herein do not constitute legal advice offered by Kinetic and are provided solely for informational and educational purposes. While the information and statistical data contained herein are based on sources believed to be reliable, Kinetic does not represent that it is accurate and should not be relied on as such or be the basis for a decision. Kinetic Financial & Insurance Solutions, Inc. and Kinetic Investment Management, Inc. are two separate entities. Insurance products and services are offered and sold through individually licensed and appointed agents in all appropriate jurisdictions under Kinetic Financial & Insurance Solutions, Inc. Investment Advisory Services are offered through Kinetic Investment Management, Inc. a registered investment adviser.
A REIT is a real estate investment trust. For example, Simon Property Group (SPG) is a REIT that owns, develops, and manages retail real estate properties including malls, outlets, and community and lifestyle centers. In that sense, SPG is comparable to a stock, such as IBM. You can purchase shares of SPG just as you might purchase shares of IBM stock. Or, you can invest money in real estate mutual fund, such as Vanguard REIT Index Investor (VGSIX) or Vanguard REIT Index ETF (VNQ) that own a large number of individual REITs within the mutual fund (or ETF).
Starting your real estate investing with a REIT mutual fund or REIT exchange traded fund (ETF) makes a lot of sense because you have immediate diversification across a large number of individual REITs. A REIT mutual fund or ETF is an important element in a diversified portfolio of mutual funds. Other funds in your overall portfolio would invest in large US stock, mid cap US stock, small cap US stock, non-US stock, stock in emerging non-US economies, US bonds, US inflation protected bonds, non-US bonds, and cash. It often requires 10-12 different mutual funds to be fully diversified.