I attended a course on Financial Literacy, and it is intriguing to learn about the various investment opportunities available in the market. One particular topic that piqued my interest was Real Estate Investment Trusts (REITs). During the course, we discussed the potential benefits and risks associated with investing in REITs, but I got caught up in the difference between REITs and ETFs. Anyone can help lay out the key differences and recommendations for beginners?
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3 Answers
A REIT specializes in real estate investments, typically either focused on commercial property, mortgages or residential rentals, with the income coming from lease, mortgage, or rent payments, and growth from the (hopefully) increase in property values.
An ETF is simply a mutual fund which is traded throughout the trading day. Traditional mutual funds, which are pooled funds from many investors that invest in a variety of stocks or other instruments that would be cost-prohibitive to most individuals, only trade at the end of each day, since the bookkeeping required to determine the value was not as easy before the prevalence of computers. ETFs trade more like stocks, and have a more complicated structure to ensure that the price they trade at matches the value of the investments it owns (the price is determined by market supply and demand and can sometimes "disconnect" from the securities it owns). They commonly track indexes, but not always.
So ETFs are a much more broad category. There are many ETFs that buy REITs, and can be an easier way to invest in a broad selection of REITs rather than doing the research needed to pick an individual REIT (think of it as investing in hundreds of companies versus trying to choose one stock to buy)
Owning shares of a REIT is buying part ownership in a specific real estate company. There are three categories of REITs with the first one comprising ~90% of available REITs
Equity REITs invest directly in income producing properties Mortgage REITs invest in mortgages Hybrid REIT invest in both
REITs often specialize in a particular property type such as commercial, retail, residential, multi-family, etc. REITs are chosen for their high income production. A REIT is a non-taxable entity as long as >75% of the company assets are invested in real estate and as long as >90% of the REITs income is paid out as dividends. Basically REITs themselves don't pay corporate taxes leaving more profits for shareholders than traditionally taxed corporations. Typically REITs make great additions to income portfolio to further diversify the fixed income portion of the allocation beyond bonds.
REIT ETFs will trade more like a stock but retain it's income characteristics. They comprise multiple REITs and potentially non-REIT but real estate sensitive securities. The could be specialized to a particular type of REIT but often include broad exposure to multiple types of REIT. They still provide income driven returns but prevent the investor from having to do "due diligence" into a specific company. As an ETF they are likely a bit more volatile than the average individual REIT, but greatly reduce the risk of you having picked "the wrong" individual company. The REIT ETF will have some small internal expenses in addition to the cost of the REITs it contains since even if indexed there is still a fund manager.
For both REITs and REIT ETFs the income generated is "non-qualified" and will likely be taxed at marginal income tax rates.
In general REIT ETFs make a simpler addition to a portfolio looking to diversify. Think buy a bond vs buying a bond fund.
In writing this I referenced the investopedia article to jog my memory: https://www.investopedia.com/articles/investing/081415/reits-vs-reit-etfs-how-they-compare.asp
ETF (exchange traded funds) are an alternative way to access mutual funds. It's still the same kinds of funds behind them; for almost any mutual funds there's a near-equivalent ETF and vice versa. I've never fully understood the advantage of ETFs (if there is one) for folks like myself who invest rather than trade, so I've mostly ignored them, but there doesn't seem to be much if anything actively wrong with them.
REIT is a general class of mutual funds intended to offer returns based on the profitability of the real estate market, often with an emphasis on commercial real estate.
An index fund is designed to roughly track the performance of a defined group of stocks or bonds, usually those in one of the established market indexes (hence the name) automatically, with minimal human interference. Non-index mutual funds typically charge a much higher fee to manage your money, under the theory that a human can make better investment decisions from moment to moment than just investing in a mix that resembles the index. Which is true, but they usually don't do enough better, and after the fees are figured in you are often better off with the index after all. (Websearch "Buffet bet".)
You can put those together to understand the two alternatives you're asking about. REIT funds are available in both traditional and ETF forms, and as both managed and index funds, in all the possible combinations. I'd suggest index funds, and I've not used ETFs so I have little opinion about them; hopefully someone else can explain that to both of us.
