Equity REIT vs. Mortgage REIT
Two main types of real property investments trusts (REITs) are available for investors: equity REITs or mortgage REITs. Equity REITs are property owners and operators, while mortgage REITs purchase mortgages and other assets.
What Is A REIT?
REITs are security that has real estate and other real-estate-related assets. REITs can trade on major exchanges and are very similar to stocks. REITs are a way for companies to purchase real estate and mortgages through combined investments from a group of investors. This type of investment allows both large and small investors to own shares in real estate without having to purchase, finance, or operate it.
REITs must have at least 100 investors. Regulations prevent what could be considered a dangerous workaround: allowing a few investors to own the majority of the REIT's interest.
A REIT must have at least 75% assets in real property and at least 75% gross income from rents, mortgage interest, or gains from the sale.
REITs must also pay dividends to shareholders at least 90% of their annual taxable income (exempting capital gains). However, this restriction limits the REIT's ability to use internal cash flow to grow.
Equity REITs
The most popular type of REIT is the equity real estate investment trust. They manage, acquire, renovate and sell income-producing real property. They primarily make their income from rental incomes from real estate.
Equity REITs generally provide steady income. These REITs make their revenue from rents and are easy to predict and grow over time.
Mortgage REITs
Mortgage REITs (also known mREITs) invest in mortgages, mortgage-backed securities (MBS), and other assets. Mortgage REITs generate income from interest, while equity REITs usually make revenue from rents.
As an example, let's say company ABC is a REIT. With the money raised from investors, it buys an office building and rents office space. Company ABC manages the real estate and collects rent from its tenants every month. Therefore, Company ABC can be considered an equity REIT.
Assume company XYZ is a REIT that lends money out to real estate developers. However, unlike the company ABC company XYZ earns interest on its loans. Company XYZ, therefore, is a mortgage REIT.
Most profits from mortgage REITs are paid out to investors in dividends, just like equity REITs. When interest rates rise, mortgage REITs perform better than equity REITs.
Equity And Mortgage REIT Risks
As with all investments, both equity REITs as well as mortgage REITs come with their risks. These are some of the risks that investors need to be aware of:
Equity REITs are cyclical and can be sensitive during periods of economic decline and recessions.
Equity REITs can have too many supplies, such as more hotel rooms than the market can handle, leading to lower rental income and higher vacancies.
Mortgage REITs can be affected by changes in interest rates. Lower interest rates can also encourage more borrowers to repay or refinance their mortgages, and the REIT must reinvest at lower rates.
The federal government backs most mortgage securities REITs purchase, which reduces credit risk. Some mREITs, however, may be more at risk depending on their investments.
The Summary
REITs allow investors to access the real estate market without owning, financing, or operating properties. Dividends must be paid out to shareholders by both equity and mortgage REITs. These dividends are often more than stocks.
Equity REITs can be appealing to investors who are looking for both income and growth. However, mortgage REITs may be more suitable for risk-tolerant investors looking for maximum income and less capital appreciation.
