Stocks vs. Mortgage REITs: What’s the Difference?

Stocks vs. Mortgage REITs: An Overview

There are different types real estate investment funds (REITs), including equity REITs, mortgage REITs and hybrid REITs. A REIT is a type of security in which the company owns and generally operates property or real estate-related assets. REITs are similar to stocks and trade on major market exchanges.

REITs allow companies to purchase real estate or mortgages using combined investments from their investors. This type of investment allows large and small investors to own a stake in real estate.

A significant percentage of equity REIT profits are paid out to investors as dividends. Equity REITs tend to perform better when interest rates are low and real estate prices are rising. However, the complexity of the different markets covered by equity REITs means that opportunities are almost always available.

Key Takeaways

• REITs are stock-like securities that allow investors large and small to add real estate holdings to their portfolios.
• Equity REITs are responsible for acquiring, managing, building, renovating and selling real estate.
• Mortgage REITs generally lend money to real estate buyers to acquire existing mortgages or invest in mortgage-backed securities (MBS).

Equity REITs

Equity REITs invest in hard real estate assets. Equity real estate investment trusts’ income is generated primarily from rental income from their real estate holdings. Equity REITs typically invest in offices, industrial buildings, retail, residential, hotels and resorts.

Equity REITs generate income from renting real estate, as well as from buying undervalued properties and selling them for a profit. Some equity REITs are diversified and invest in different real estate categories, such as retail spaces and apartments.

Other REITs focus on smaller segments of the real estate market, such as retail or hotels.

Remark

REITs incur a variety of costs/fees, such as management fees, upfront costs, administrative fees, marketing costs and acquisition costs, which reduce overall returns.

Mortgage REITs

Mortgage REITs invest only in mortgages and make up a small portion of the REIT market. While equity REITs typically generate their income from renting out real estate, mortgage REITs generate their income primarily from the interest earned on their mortgage loans. They also trade and invest mortgage-backed securities.

There are commercial mortgage REITs and residential mortgage REITs, and some mixed REITs invest in both commercial and residential REITs.

As with equity REITs, the majority of mortgage REIT profits are paid out to investors as dividends. Mortgage REITs tend to perform better during times of rising interest rates. However, like equity REITs, there are so many different target markets that mortgage REITs almost always have investment options available.

Hybrid REITs

Hybrid REITs invest in both real estate and mortgages. By investing in both mortgages and hard assets, hybrid REITs take a more balanced approach and can potentially benefit from both rising and falling interest rate environments where traditional equity-only or mortgage-only REITs struggle.

What is a REIT?

A Real Estate Investment Trust (REIT) is an entity that owns, operates or finances income-producing real estate. Investors can invest in REITs by purchasing shares, which gives them exposure to real estate without having to directly own real estate. REITs are required by law to pay out at least 90% of their income as dividends, making REITs a strong contender for stable income payments.

How do I invest in a REIT?

You can invest in a REIT by purchasing one in your investment account. You’ll first need to open a brokerage account like E*Trade, deposit money into the account, and buy a publicly traded REIT like you would a stock. Before purchasing a REIT, research the specific REIT to determine whether it meets your investment goals and risk tolerance.

What is the 90% rule for REITs?

The 90% rule for REITs states that REITs are required by law to distribute 90% of their income as dividends to investors each year. For investors, this ensures a consistent income payment, and for REITs, this keeps taxes low, allowing more income to be paid out as dividends.

The bottom line

Both equity and mortgage REITs allow you to invest in the real estate market, but they offer different investment options. Equity REITs generate income from rent, while mortgage REITs generate money from loans and mortgage-backed securities (MBS).

Each type of REIT performs better under certain market conditions, which can help guide investment decisions. Equity REITs work better in low interest rate environments, while mortgage REITs work better in high interest rate environments. Hybrid REITs offer investors a balanced investment approach.