There are two major types of REIT investing
equity REITs and mortgage REITs.
Before we delve into the details of the different types of REITs and their risk, let us know something about real estate investment trust or REIT.
What does a REIT do?
A real estate investment trust is like a mutual fund for the real estate sector. Here, money from numerous investors is pooled and invested by companies in the real estate-related asset or in purchasing or mortgaging real estate.
REITs are similar to shares and are traded on all major stock exchanges. These investments allow all kinds of investors to invest in real estate without owning, managing, or financing them.
Both equity REITs and mortgage REITs are traded on all primary stock exchanges, excluding private or non-listed REITs.
So how are equity REITs and mortgage REITs different?
Let us understand the two types of REITs.
What are Equity REITs?
Equity REITs are companies that manage or own real estate properties like commercial buildings, shopping centers, or residential buildings. Income on equity REITs is generated from the rents, property value appreciation, and income generated from the business directly involved with the real estate.
Income derived from the real estate is paid back as a dividend to the shareholders annually after deduction of the overall expense for such properties.
The various sectors where equity REITs invest include:
- Retail REITs
- Healthcare REITs
- Industrial REITs
- Hospitality REITs
- Data Center REITs
- Infrastructure REITs
- Office REITs
- Residential REITs
- Diversified REITs
- What Are The Different Types Of REITs
- Direct Real Estate Investing Vs. REITs
- How To Invest In REITs
- What Is A Captive Real Estate Investment Trust
Benefits of equity REITs
From an investment perspective, the benefits of equity REITs investments include:
Income from Dividend
The larger portion of the REIT investment return is in the form of dividends. Equity REIT dividend yields are more than the average returns. This makes it an attractive investment option for many investors.
While investing, many investors have the thought of ensuring income for some time. Listed REITs provide a cushion against inflation to help such investors. Even in an inflation period, the rents and prices of commercial real estate provide a steady income to the investors.
Diversification of Portfolio
Equity REITs have important portfolio diversification because of their fairly low correlation with other assets that include bonds, stock, etc. It is a benefit for investors since diversification reduces portfolio volatility. However, the diversification with REITs is restricted to different parts of the same asset class.
Liquidity and Transparency
While real estate investments are never considered as liquid investments, with REITs investments, the case is different. Listed REITS make real estate investments transparent and liquid. REITs provide real-time pricing and evaluation. Since the listed REITs in the U.S. are registered and managed by the SEC, following the standards of corporate governance and reporting is mandatory.
Risks involved with Equity REITs
Prices of the equity REITs heavily depend on the market scenarios and are susceptible to variations. Commercial real estate can be unpredictable at times, though the market cycle of a real estate differs from the market cycle of other stocks. The price change in the portfolios of the REITs affects the price of the shares. (Always keep this piece of information in mind before investing.)
What are Mortgage REITs?
Mortgage REITs or mREITs are REITs investing where investors hold an equity investment in the mortgage market with the transparency and liquidity of publicly traded equities. Investors can buy multiple shares listed on the stock exchanges or purchase in the form of mutual funds or ETFs. Some mREITs are registered with SEC but not listed. These REITs can also be held privately.
Benefits of mREITs
With mREITs, the income is created from the interest received by investing in commercial and residential mortgages. Approximately 10% of the total REIT investments are in mortgages. These REITS also generate income from mortgage-backed securities. mREITs provide funding for a mortgage for both businesses and homeowners. This type of REITs provides credit and liquidity to home mortgage markets.
Risks involved with mREITs
Changes in the interest rates can affect the value of the mortgage assets and subsequently the net interest margins. This can have a negative impact on corporate net worth. Managing the interest rate is essential in mREITs.
mREITs can be exposed to credit risk through private labels. The amount of risk depends on how the underlying loan and structure of the security performs. Over-collateralization can also be responsible for credit risk.
There is always a possibility that borrowers will repay or refinance their mortgages with the change in interest rates. When refinancing happens, the investor who holds the mortgage must reinvest in the prevailing interest rates, which could be lower or higher.
Always remember to consult your financial planner, advisor, or broker who can help you analyze your financial objectives and recommend the right type of REIT investment. Like any other investment, REIT investments also carry a certain amount of risk.
However, what goes for the REITs is that they are great for diversifying investments outside the traditional formats and are attractive for their long-term capital appreciation and strong dividends.