Both real estate investment trusts (REITs) and exchange-traded funds (ETFs) that invest in REITs offer some benefits of real estate investing, without having to own any properties directly. The main differences between a real estate ETF vs. REIT lie in how they’re structured, dividend payouts, taxes, and the fees investors might pay to own them.
Also, REITs are considered alternative investments, which means they tend not to move in sync with traditional investments like stocks and bonds.
Key Points
• REITs and REIT ETFs offer benefits of real estate investing without direct property ownership.
• Differences between REITs and REIT ETFs include structure, dividend payouts, taxes, and fees.
• REITs are considered alternative investments and may not move in sync with traditional investments.
• REITs generate income through rents, while REIT ETFs own a collection of REIT investments.
• Investors can buy and sell shares of REIT ETFs on stock exchanges, while REITs can be publicly traded, non-traded, or private.
Overview of REITs
A real estate investment trust is a legal entity that owns and operates income-producing properties. REITs can hold a single property type or multiple property types, including:
• Hotels and resorts
• Self-storage facilities
• Warehouses
• Retail space, including shopping centers
• Apartment buildings or multi-family homes
• On-campus housing
• Assisted living facilities
REITs that own and manage properties typically generate most, if not all, of their income through rents. Some REITs may also invest in mortgages and mortgage-backed securities. REITs that invest in mortgages can collect interest on those loans.
There are two conditions to qualify for a REIT. A company must:
• Derive the bulk of its income and assets from real estate-related activities
• Pay out at least 90% of dividends to shareholders
Companies that meet these conditions can deduct all of the dividends paid to shareholders from corporate taxable income.
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What Is a REIT ETF?
An exchange-traded fund or ETF is a pooled investment vehicle that shares some of the features of a mutual fund but trades on an exchange like a stock. A REIT ETF is an exchange-traded fund that owns a basket or collection of REIT investments.
While REITs own properties, REIT ETFs do not. REIT ETFs have a fund manager who oversees the selection of securities held in the fund. The fund manager also decides when to sell off fund assets, if necessary.
A REIT ETF may be actively or passively managed. Actively managed ETFs often pursue investment strategies that are designed to beat the market. Passively managed ETFs, on the other hand, aim to mimic the performance of an underlying market benchmark or index.
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How REIT ETFs Work
REIT ETFs work by allowing investors to gain exposure to a variety of real estate assets in a single investment vehicle. For example, a REIT may hold:
• Stocks issued by REITs
• Other real estate stocks
• Real estate derivatives, such as options, futures, or swaps
Investors can buy shares of a REIT ETF on a stock exchange and sell them the same way. Like other ETFs, REIT ETFs charge an expense ratio that reflects the cost of owning the fund annually. Expense ratios for a REIT ETF, as well as performance, can vary from one fund to the next.
REIT ETFs pay dividends to investors, which may be qualified or non-qualified. The fund may give investors the option to reinvest dividends vs. collecting them as passive income. Reinvesting dividends can allow you to purchase additional shares of a fund, without having to put up any money out of pocket.
A REIT ETF might track the performance of the MSCI US Investable Market Real Estate 25/50 Index, which offers investors access to multiple REIT property sectors, including:
• Data centers
• Health care
• Hotels and resorts
• Office space
• Industrial
• Real estate
• Retail
• Telecom
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
What’s the Difference between REITs and REIT ETFs?
REITs and REIT ETFs both offer opportunities to invest in real estate, without requiring investors to be hands-on in managing property. There are, however, some key differences to know when considering whether to invest in a REIT vs. REIT ETF.
Structure
REITs are most often structured as corporations, though they can also be established as partnerships or limited liability companies (LLCs). The Internal Revenue Service (IRS) requires REITs to have a board of directors or trustees who oversee the company’s management. As mentioned, REITs must pay out 90% of dividends to shareholders to deduct those payments from their corporate taxable income.
A REIT may be categorized in one of three ways, depending on what it invests in.
• Equity REITs own properties that generate rental income.
• Mortgage REITs focus on mortgages and mortgage-backed securities.
• Hybrid REITs hold both properties and mortgage investments.
REIT ETFs are structured similarly to mutual funds, in that they hold multiple securities and allow investors to pool funds together to invest in them. The fund manager decides which investments to include and how many securities to invest in overall.
Both REITs and REIT ETFs are structured to pay out dividends to shareholders. And both can generate those dividends through rental income, mortgage interest, or a combination of the two. The difference is that structurally, a REIT ETF is a step removed since it doesn’t own property directly.
Investment Style
REITs and REIT ETFs can take different approaches concerning their investment style. When comparing a REIT vs. REIT ETF, it’s helpful to consider the underlying investments, fund objectives, and management style.
An actively managed REIT, for example, may generate a very different return profile than a passively managed REIT ETF. Active management can potentially result in better returns if the REIT or REIT ETF can beat the market. However, they can also present more risk to investors.
Passive management, on the other hand, typically entails less risk to investors as the goal is to match the performance of an index or market benchmark rather than exceed it. Fees may be lower as well if there are fewer costs incurred to buy and sell securities within the fund.
How They’re Traded
Individual REITs can be publicly traded, public but non-traded, or private. Publicly traded REITs are bought and sold on stock market exchanges and are regulated by the Securities and Exchange Commission. Public non-traded REITs are also subject to SEC regulation but they don’t trade on exchanges.
Private REITs, meanwhile, are not required to register with the SEC, nor are they traded on exchanges. These types of REITs are most often traded by institutional or accredited investors and may require higher buy-ins.
REIT ETFs trade on an exchange like a stock. You can buy shares of a REIT or REIT ETF through your brokerage account. If you decide you’re no longer interested in owning those shares you can sell them on an exchange. Unlike traditional mutual funds, share prices for REIT ETFs can fluctuate continuously throughout the day.
The Takeaway
Real estate can be an addition to a portfolio for investors who are interested in alternative investments. Whether it makes sense to choose a real estate ETF vs. REIT, or vice versa, can depend on your short and long-term financial goals, as well as your preferred investment style.
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FAQ
Do REIT ETFs pay dividends?
REIT ETFs pay dividends to investors. When considering a REIT ETF for dividends, it’s important to assess whether they’re qualified or non-qualified, as that can have implications for the tax treatment of that income.
What are the risks of investing in REITs?
REITs are not risk-free investments, and their performance can be affected by a variety of factors, including interest rates, shifts in property values, and limited liquidity. In some cases, the dividend payout from a REIT can provide steady returns, but this is not always the case, as real estate conditions can fluctuate.
Do REITs have fees?
REITs can charge a variety of fees, which may include upfront commissions, sales loads, and annual management fees. REIT ETFs, meanwhile, charge expense ratios and you may pay a commission to buy or sell them, depending on which brokerage you choose. Evaluating the fees for a REIT or REIT ETF can help you better understand how much of your returns you’ll get to keep in exchange for owning the investment.
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