What is the Difference Between a REIT and a Real Estate Fund?
A REIT and a real estate fund are two different financial terms. A real estate fund acts as a mutual fund and can invest in a basket of securities, including REITs. It doesn’t necessarily pay dividends but is similar to a stock; it appreciates. On the other hand, REITs are actual companies that own real estate, generating income.
As per the Securities and Exchange Commission, REITs must pay out 90 percent of their taxable income each year to shareholders through dividends. Investors can purchase REITs similar to buying stocks or ETFs on the stock exchange.
What are REITs?
REITS, according to the Securities and Exchange Commission, are companies that own and operate income-producing real estate and related assets. This means these companies pool together money from investors to buy properties. These properties can range from apartments to shopping complexes and even warehouses.
There are three types of REITs you can invest in. Equity REITs are companies that own these properties firsthand. They get rental income from commercial real estate offices, shopping centers, and more. Mortgage REITs, on the other hand, are companies that invest in mortgages and mortgage-backed securities, which are investments similar to bonds. The revenue of these companies comes from interest in these vehicles.
Last but not least, Hybrid REITs are a mixture of both Equity and mortgage REITs. They own physical properties that produce rental income and invest in real estate securities.
What are Real Estate Funds?
Real estate funds take many forms, from exchange-traded funds to active and closed-managed mutual funds to private real estate investment funds.
A real estate fund that’s an ETF will trade on a major stock exchange such as the S&P and is made up of shares of REITs and other real estate companies. Anyone can access an ETF through online investing platforms such as Ameritrade or Robinhood, a commission-free stock trading mobile application.
On the other hand, a real estate fund can also take the form of a mutual fund privately managed by a fund manager. These fund managers pick which real estate stocks, REITs, ETFs, and other securities enter the fund. They will crunch numbers and do their technical analysis to work in the best interest of the investors. The larger the fund is, the more other analysts will join the fund manager to maintain the fund.
Real estate funds make money through a couple of different pathways. These include rental income, property appreciation, and capital gains once the securities are sold. Fund managers will distribute the rental income after subtracting their management fees.
Considerations for Investing in REITs vs. Real Estate Funds
Every investor is unique, with their own financial situation, goals, and risk tolerance. It’s essential to consider your individual circumstances when deciding between REITs and real estate funds. Let’s explore some factors you might weigh:
- Liquidity: REITs, being traded like stocks on the stock exchange, offer liquidity. This means you can quickly buy or sell your securities during trading hours.
- Passive Investment: For those who’d rather invest in a range of properties without the effort of directly managing them, REITs provide an avenue.
- Dividend Investing: If the idea of receiving regular dividends appeals to you, REITs can be an option.
- Accessible Entry Point: With platforms offering fractional shares, one can start investing in REITs with a minimal initial amount.
Real Estate Funds
- Active Participation: Even with fund managers at the helm, real estate funds can allow investors a degree of influence over their portfolios.
- Long-term Investment: These funds typically cater to long-term goals, making them suitable for investors thinking of milestones like retirement.
- Exclusive Opportunities: Real estate funds can offer access to larger-scale properties, which might not be available to the general public.
- Higher Risk Tolerance: As your capital will remain invested for longer durations, you should be comfortable with facing market fluctuations over the years.
- Limited Control: You have no say over the property selections within a particular REIT.
- Market Volatility: REITs can be sensitive to interest rate changes and broader economic factors.
- Tax Implications: Selling REITs might result in a taxable event, which can impact your overall returns.
Real Estate Funds
- Less Liquidity: Unlike REITs, real estate funds can’t be traded easily on stock exchanges, and there might be penalties for early withdrawals.
- Capital Requirements: Some funds might require a substantial initial investment.
- Management Fees: The costs associated with managing the fund can eat into your returns.
Your Next Steps
It’s essential to remember that every investment has its advantages and challenges. Engaging with a trusted financial advisor can provide clarity. They can highlight the perks and pitfalls of each option, tailored to your personal situation. Ultimately, the choice you make should resonate with your financial objectives and comfort level.
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