Understanding REITs and Mutual Funds: Differences, Similarities
These two types of investment share many similarities, but there are key distinctions between them.
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When it comes to real estate investing, there are many different vehicles and strategies open to investors. Two popular real estate investment vehicles are often confused with each other: real estate investment trusts (REITs) and real estate mutual funds. After all, both stand up as easily accessible, low-risk entry points for real estate investing, and both are liquid investment vehicles. But while the two do share those similarities and more, they are not the same.
Since there is no shortage of REITs and real estate mutual funds on the market for investors to consider, it is important to understand the nuances of each before making an investment decision. In this article, we’ll explore what makes each unique as well as some key investor considerations.
Real Estate Investment Trusts
Real estate investment trusts are entities that own, operate, and/or arrange financing for income-producing real estate. In a REIT, multiple investors pool capital to make these real estate investments. REITs provide many benefits to investors, including regularly distributed dividends and a reasonably low-risk level.
Most REIT portfolios focus on a specific sector containing any number of income-generating assets. Real estate investment trusts exist for asset types across the board, including multifamily communities, healthcare facilities, office buildings, retail centers, hotels, self-storage facilities, and more. There are even specialty REITs that focus on infrastructure, covering energy conduits, pipelines, cell towers, and other similar assets.
REITs are often categorized into three different types: equity, mortgage, and hybrid REITs. Equity REITs are the most common. These focus on holding and sometimes operating income-generating real estate, with rental income providing the basis for returns. Mortgage REITs focus primarily on lending money to commercial real estate investors, with interest driving returns. Hybrid REITs are mashups of equity and mortgage REITs, offering both sources of investor returns.
Real Estate Mutual Funds
A mutual fund is a professionally managed group of investment pools that focus on a variety of different investment vehicles. Real estate mutual funds are often focused on investments in REITs and real estate companies — which include real estate brokers, property management companies, and real estate software companies. These funds typically include a diverse mixture of shares of REITs and these real estate companies.
Real estate mutual funds almost always have a professional portfolio manager and are typically constructed after significant expert research. Investors of real estate mutual funds purchase stakes in the form of shares or units, which are acquired at the price set by the fund’s net asset value. That value is calculated daily, based on the different closing prices of the securities included in the fund.
Investor Considerations
REITs and real estate mutual funds both offer an opportunity to invest in commercial real estate without needing to make a substantial capital investment. Depending on the diversification of the holdings, they can also offer a significant buffer against risk. The performance of real estate mutual funds is significantly correlated with the performance of REITs, and both vehicles tend to react similarly to trends in the market. Investors can expect to earn dividends from either vehicle, and both investments can be considered hedges against inflation.
Real estate mutual funds, unlike REITs, carry an opportunity for capital appreciation over medium- to long-term holding. REITs, on the other hand, are required to distribute 90% of their revenues as dividends to their investors — leaving only 10% for further investment. Real estate mutual funds are known to carry higher maintenance fees than REITs, but they have the added benefit of in-depth market research and professional portfolio management. Even so, REITs are considered the more liquid of the two and carry fewer tax implications for investors.
Related Questions
What is the difference between a REIT and a mutual fund?
REITs and real estate mutual funds both offer an opportunity to invest in commercial real estate without needing to make a substantial capital investment. Depending on the diversification of the holdings, they can also offer a significant buffer against risk. The performance of real estate mutual funds is significantly correlated with the performance of REITs, and both vehicles tend to react similarly to trends in the market.
The main difference between REITs and real estate mutual funds is that REITs are required to distribute 90% of their revenues as dividends to their investors — leaving only 10% for further investment. Real estate mutual funds, on the other hand, carry an opportunity for capital appreciation over medium- to long-term holding. Real estate mutual funds are also known to carry higher maintenance fees than REITs, but they have the added benefit of in-depth market research and professional portfolio management. Even so, REITs are considered the more liquid of the two and carry fewer tax implications for investors.
What are the advantages and disadvantages of investing in REITs?
Advantages of Investing in REITs include:
- Easy to buy and sell, making them a relatively easy starting point in commercial real estate investment.
- Reduces the need for an investor’s hands-on property and operations management.
- Stable dividend paid out at regular intervals.
- Have managed to outperform the S&P 500 and the rate of inflation over the course of the last 20 years.
- Attractive risk-adjusted returns.
- Dividends that can be earned from them are often much higher than any dividends that can be achieved through most other investment vehicles.
Disadvantages of Investing in REITs include:
- Not necessarily the best investment vehicle in terms of capital appreciation.
- REITs are required to pay no less than 90% of their taxable income to investors as dividends — leaving only a meager 10% which can be reinvested by new acquisitions or capital improvements.
What are the advantages and disadvantages of investing in mutual funds?
Investing in real estate mutual funds has both advantages and disadvantages. The advantages include professional portfolio management, low initial entry cost, limited risk, relatively high liquidity, potential for capital growth, and passive real estate investment. The drawbacks include no control over the fund’s operation, no passive income, subject to both real estate market and stock market trends, fewer tax benefits, and higher maintenance fees.
For more information, please see this article.
What types of investments are included in REITs?
REITs typically focus on a specific sector containing any number of income-generating assets. Real estate investment trusts exist for asset types across the board, including multifamily communities, healthcare facilities, office buildings, retail centers, hotels, self-storage facilities, and more. There are even specialty REITs that focus on infrastructure, covering energy conduits, pipelines, cell towers, and other similar assets.
What types of investments are included in mutual funds?
Real estate mutual funds typically include a diverse mixture of shares of REITs and real estate companies — which include real estate brokers, property management companies, and real estate software companies. (Source)
Real estate mutual funds operate like REITs in that they are also structured around capital pooled from multiple investors, but they pull the focus back a step farther, targeting investments in different REITs as well as a plethora of different types of real estate companies — including real estate software companies, real estate brokerage firms, and even property management companies. (Source)
What are the tax implications of investing in REITs and mutual funds?
REITs are considered the more liquid of the two and carry fewer tax implications for investors. According to Investopedia, REITs are not subject to corporate income tax, and investors are only taxed on the dividends they receive. Mutual funds, on the other hand, are subject to capital gains taxes when the fund is sold, and investors are taxed on the dividends they receive.