It has been years since real estate investments have gained popularity as a way to earn. Investing in real estate means buying or acquiring property for income and capital appreciation. These properties can come in the form of residential, commercial, retail, and leisure properties.
One avenue for investing in real estate is through passive investment. Passive investors contribute funds to a project without being directly involved in managing them.
However, the catch is that they still receive returns from it. The management is done through experienced property managers making real estate both a tangible asset and an investment opportunity.
Among many passive real estate investment opportunities, investors usually choose from either a REIT or a Real Estate Mutual Fund.
So, what are these two investment methods? which one is better than the other?
Let’s debunk the differences between REITs and Real Estate Mutual Funds in the following article!
Sneak Peak At The Differences Of REITs and Real Estate Mutual Funds
| REITs | Real Estate Mutual Funds | |
| How liquid is it? | These have high liquidity and are traded on the stock exchange. | These have lower liquidity and can only bought or sold at the end of a trading day at the net asset value (NAV) |
| Minimum required investment | No limit | May have a minimum investment requirement of between $500 to $ 5000 |
| How are they managed? | Mostly managed through a company or Managers due to its fully passive nature. | Can be actively or passively managed |
| What is the tax structure? | 90% of taxable income has to be distributed to shareholders | May have varying tax implications depending on factors such as fund structure and investment strategy |
| How volatile Are They? | Highly volatile to property value fluctuations | Lower than REIT as a mutual fund can have many different investments in different sectors |
| How diversified are the portfolios? | They consist of only one type of investment: Investment in real estate | Highly diversified as a Mutual Fund can have investments in many different markets, not just limited to real estate |
Understanding REIT (Types And Divided Incomes)
A real estate investment trust (REIT) is a company that owns, operates, or finances real estate that generate income.
Just like mutual funds, REITs allow you to earn dividend income from your investments. Through REITs, investors can participate in real estate portfolios by buying company stock, mutual funds, or exchange-traded funds (ETFs).
REIT shareholders earn income from property rents without the hassle of property management.
Primarily there are 3 types of REITs:
- Equity REIT: Equity REITs own properties like apartments and malls.
- Mortgage REIT: Mortgage REITs invest in mortgages and earn income from interest payments.
- Hybrid REITs: Hybrid REITs combine both as a result giving investors a balanced investment strategy.
Understanding Real Estate Mutual Funds
Real Estate Mutual funds are privately held and managed by fund managers for a management fee. They have the liberty to select real estate stocks, REITs, and ETFs for the fund.
They analyze data and conduct technical analysis to benefit investors. Real estate funds generate income through rental income, property appreciation, and capital gains after selling securities.
Real Estate Funds come in various forms such as ETFs, actively managed mutual funds, and private investment funds. ETFs are made up of shares of REITs and real estate companies.
REITs vs. Real Estate Mutual Funds: 6 Major Differences
When talking about REITs vs Real Estate Mutual Funds, there are a few key major differences that most first-time investors are unaware of. They are:
1.How Liquid Are They?
REITs and real estate mutual funds differ in how liquid they are. Liquidity means how easily investors can buy and sell shares.
REITs, just like regular stocks, are very liquid as they are traded on the stock exchange. Investors can easily buy and sell REIT shares throughout the trading day.
In contrast, real estate mutual funds have lower liquidity. Investors can typically only buy or sell mutual fund shares at the end of the trading day at the net asset value.
2.Minimum Required Investment
REITs and real estate mutual funds have varying minimum investment requirements.
REITs generally have no minimum investment requirements. This means investors can purchase individual REIT shares at any price point. This accessibility makes REITs appealing to investors with varying budgets.
Real estate mutual funds usually have a minimum investment amount which varies across different countries and markets. In the USA, the minimum investment requirement is between $500 to $5000. Although not much, these floors bring up a barrier to entry for small investors.
3.How Are They Managed?
REITs and real estate mutual funds vary in their management style. This has an impact on how investors make investment decisions.
REITs are mainly passive investments, where investors rely on the trust’s management to make investment decisions and manage properties. Investors in REITs have little to no control over the operations.
Real estate mutual funds may be actively or passively managed. Some real estate mutual funds are actively managed by fund managers for a hefty fee. They actively select and manage investments based on research and analysis. In actively managed funds, investors may have more control over investment decisions.
4.What Is The Tax Structure?
REITs are required to distribute at least 90% of their taxable income to shareholders. This makes them tempting for investors as they get favorable tax treatment. Dividends received from REITs are taxed at the investor’s ordinary income tax rate.
Real estate mutual funds may have varying tax implications depending on factors such as fund structure and investment strategy. Real estate mutual fund investors may face additional capital gains taxes on fund distributions and potential taxes on capital gains when selling fund shares.
5.How Volatile Are They?
REITs, directly owning real estate, face higher volatility due to several factors. Real estate values react slower than stocks. Thus it can lead to larger price fluctuations during economic downturns. Rising interest rates increase borrowing costs making it hard to refinance or acquire properties. Similarly, higher vacancy rates decrease rental income affecting dividends and share price
Real Estate Mutual Funds experience are less volatile as they consist of a diverse portfolio of investments. By investing across various REITs and real estate companies, the risk is spread. Investors can exit a fund easily if they can foresee potential future losses during market fluctuations
6.How Diversified Are the Portfolios?
REITs can have some diversification across sectors or locations but overall they are not so diverse. The market usually just consists of investment in the real estate market.
Real Estate Mutual Funds are more diversified as these funds invest in various real estate assets, including REITs and operating companies. Not only that they can even have investments in other sectors like manufacturing and IT.
FAQ
What Is The Real Estate Fund Structure?
Real estate funds are structured similarly to mutual funds or ETFs. Here investors pool money to invest in different assets such as REITs and mortgages.
Are REITs Better Than Mutual Funds?
When talking about REITs vs Real Estate mutual funds the answer is subjective. REITs offer steady dividend income and liquidity but may be more volatile. Mutual funds are more risk-averse and may be better for long-term capital appreciation.
What Are The Disadvantages Of A REIT?
REITs are sensitive to real estate market fluctuations and are slower to recover during an economic downturn They are highly impacted by rising interest and vacancy rates that can reduce dividends earned and lower share prices.
Wrapping Up On REIT vs. Real Estate Mutual Funds
There is not one true answer to which is better between REITs and Real estate mutual funds. Both have their ups and downs. Both of them give investors entry into passive real estate investing without directly owning the property themselves. REITs promise steady income best for those seeking immediate returns. Real Estate Mutual Funds offer long-term wealth.
When choosing between the two you must pen down your investment goal and the time you want to invest for. Understand the differences between these two types of passive investments well. This will not only educate you on them but will empower you to make the right investment decisions and prevent any potential future loss if you play your cards right!