Investments in real estate are gaining popularity among those who are looking for an alternative source of income. While some continue to invest in commercial or residential real estate, others are looking at different ways of making their money work for them. Managing an office or several blocks of apartments is not an easy task, considering changing tenants, a constant need for renovation and redevelopment, as well as huge competition.
Investors nowadays choose an alternative way of putting their funds in real estate. They are more likely to invest either in real estate funds or REITs (real estate investment trusts). Real estate investments have their own benefits for those people who are looking for passive income, higher returns, and constant revenue. Let’s review both real estate funds and REITs in order to find more about their peculiarities and different types, along with similarities and differences between them.
What is REIT?
Real estate investment trusts (REITs) refer to those companies that either own or operate different kinds of real estate in various property sectors that generate good income. REITs are an important part of any country’s economy.
The mechanics of investing in REITs is quite simple. Investors buy company stocks and therefore invest in real estate assets portfolios. REIT investors do not need to manage or look after any properties, as the bought share in real estate is working on them, providing dividends that come from leasing the properties.
REIT deals with numerous types of available properties:
- Residential complexes
- Data centers
- Health and wealth facilities
- Infrastructural objects
- Hospitality facilities
- Storage centers
- Retail sector
As a rule, one REIT is responsible for a single sector and does not offer diversification in terms of available properties. Nevertheless, there is a chance to find a REIT which will manage two types, like healthcare and storage or retail and wealth.
There exist three main categories of REITs, each with its own peculiarities.
Mortgage REITs do not have real estate properties to own. They provide financing to real estate owners and get their income from investments’ interest. Mortgage REITs basically give money to people who own property by providing them with loans or mortgages. Their income comes from the money they earn on provided loans along with the costs required to fund them.
This type of REITs is considered to be the most popular one and has the biggest number of companies in it. These types of companies deal with income-generating real estate properties. The vast majority of revenue comes from leasing the properties.
Hybrid REITs are a combination of two: equity and mortgage trusts. Such companies invest not only in properties that generate income but also in mortgages which finance real estate. There are not many companies that can be considered hybrid REITs. However, those who are getting great benefits. By combining two kinds of investments, they manage to get a profit from both, and when one of them is not at its best, another one manages to balance.
Pluses and minuses of REIT investments
REITs, as any kind of real estate investment, possess both positive and negative sides. The good thing about investing in REIT is, first of all, getting good dividends. REITs are obliged to pay annually 90% of revenue, which is as well taxable. That is a great opportunity for the investors to get the money without having to do anything related to the property on their own — no maintenance or redevelopment duties are required. In return, investors need to pay the taxes related to the received dividends. REITs, considering their overall performance, provide for the investors’ risk-adjusted returns and can be easily sold or, if needed, traded.
As for the disadvantages of REITs, the companies are obliged to pay property taxes, which can go up to 25% of the total funds. On the other hand, REITs, as a rule, do not get an increase in the value of the assets as the real estate funds do. Another minus will be a lack of diversification as REIT is generally responsible for only one sector of real estate properties, which does not allow a great variety of choice for the investors.
What is a Real Estate Fund?
Real estate funds are mutual funds where the investments are going towards securities in a direct way, through a real estate company or REITs. Real estate funds are valuable due to their opportunity to increase value through appreciation. The funds also offer a good list of assets and greater diversification when it comes to property sectors.
Real estate funds can have investments in commercial properties, inland, and even in apartments. The main idea of any real estate fund is for the money invested in having a good valuation. The funds invest most of their money into visible real estate assets, which can be easily valued. A part of the capital of real estate funds is held in financial assets in order to secure the payout.
Types of real estate funds
The existing real estate funds are generally divided into three main types.
- Real estate exchange-traded funds
The first type of real estate funds, as a rule, possess the shares of numerous REITs and real estate companies.
- Real estate mutual funds
This type is generally divided into two: open-end and closed-end funds. The open-end ones allow the investors to join the fund or leave it any time while it is active. The closed-end one does not allow to move so freely as the investor, having invested in the fund, has to be a part of it until the capital is running through its life cycle. Real estate mutual funds can be managed in two ways — actively and passively. Passive management has an idea of matching the performance of an index while the active one is trying to beat it.
- Private real estate investment funds
The last type has those funds which are generally aimed at investing in real estate in a direct way. Investors, as a rule, need to make quite a big investment in order to join the fund.
Pros and Cons of real estate funds?
Real estate funds, the same as REITs, have their good sides and potential risks.
The first plus of investing in real estate funds is the offered diversification. Real estate funds give a chance to invest in properties in multiple locations and have access to different types of properties. Another great advantage of real estate funds is that they do not necessarily depend on the stability of the stock. It means that even when the stock price changes, real estate funds remain stable. Inflation is also not a problem for investors, as rising prices can even become a benefit for them. They will receive more during that period if the demand remains high. The investors will also like the opportunity to have someone managing their funds. Real estate funds offer a professional manager to look after any investments.
Same as with the REITs, investing in real estate funds take away any problems and difficulties related to managing the property. No need to worry about building renovation and maintenance, changing rents, or tenants. All is done for the investors.
If to look at the negative side of real estate funds, the first and obvious drawback is a lack of stable flow of money. The investors, looking for an alternative passive income, will not benefit from investing with real estate funds. On the other hand, real estate funds are more likely to suffer from market risks and possess lower liquidity.
What is the difference between REITs and Real Estate funds?
Even though both investments, REITs, and real estate funds, might seem very similar, they have a lot of differences which investors should take into consideration when choosing whether or not to invest in real estate. Both REITs and real estate funds make their investments into similar facilities and provide a set of benefits for investors who want to earn money and grow their potential.
There are, however, a few distinguishing features between REITs and real estate funds. First of all, while REITs aim at investing in real estate, which generates the income, the real estate funds put their capital in securities.
Secondly, when it comes to REITs, the investors are getting a passive income on a regular basis, when in real estate funds, the value is mainly gained through appreciation, and the investors do not have an opportunity to receive income within a short period of time.
Thirdly, REITs are dealing with one or two types of properties when real estate funds have access to properties in different locations under different sectors and types. Real estate funds are said to give the investors the desired variety to choose from, which gives it a big plus.
Fourthly, the costs related to real estate funds and REITs are, as a rule, drastically different. The number of investments, as well as further fees related to management and securities in real estate funds, are higher than in REITs. Real estate funds are carefully choosing their future partners and investors possessing high standards. The last should have the ability to contribute to stable investments. In REITs, the price of a share is the only requirement to invest.
Another difference between the two types of investments is in the way investors get their revenue. In REITs, the investors get their capital on an annual basis and receive up to 90% of funds generated from the leases and rents. In real estate funds, all the income generated from mutual funds stays in the fund and will be there until the investor decides to sell it.
There is also a difference in liquidity of REITs and real estate funds. REITs are considered to be way more liquid than real estate funds. The stocks in REITs can be easily traded at any time an investor wishes to. The number of shareholders allowed in REITs reaches a hundred, which is a great opportunity to expand the base. The distributions paid in REITs reach a high level, which is another way to offset the risks. In real estate funds, the liquidity levels are dependent on the operating agreement and have a number of transfer restrictions.
Last but not least, the rules towards qualifying for REITs or real estate funds differ in many ways. In order to become a REIT, a company needs to meet quite a long list of requirements, and once accomplished, it will be asked to disclose to the Securities and Exchange Commission on a regular basis. Real Estate Funds does not have so many strict rules to follow.
Real estate investments, having its pluses and minuses, with all the difficulties along the way, remain one of the most profitable types of investment in the modern world. There is a great opportunity to choose the type that best fits the needs and the budget of the investors.
Regardless of the type of investment chosen, investors will anyway get a list of pleasant benefits. Real estate investments in REITs or real estate funds provide a good income, are not sensitive to inflation, and do not require the investors to take an active part in managing the properties.
REITs and real estate funds have many differences that need to be considered before making an investment. Despite having obvious risks and a few disadvantages, each type possesses a set of great features which allows it to attract a great number of potential investors on a regular basis. While REITs are great for those investors who are seeking regular income, do not want to pay much on entry, and want something flexible, real estate funds, on the other hand, are more attractive for those who are looking at building long-term commitment. Based on the pursued goals, investors need to make a good research on both REITs and real estate funds peculiarities and choose the one that suits their needs.
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