- A Real Estate Investment Trust (REIT) is a company that buys, sells, operates, or finances real estate.
- A REIT ETF is a hybrid product that combines the diversification of a mutual fund and the ability to buy and sell shares on a major stock exchange like a stock.
- While both investment vehicles are in pursuit of the same objective – a profitable return – they differ in key ways such as the asset selection process, diversification, and the composition of the investment portfolio.
- Benefits of a REIT or REIT ETF investment include: liquidity, diversification, income, and the potential for price appreciation
- Risks of a REIT or REIT ETF investment include price volatility, interest rate sensitivity, and taxable income on the dividends paid.
- For Accredited Investors with a long term investment horizon, an individually syndicated private equity deal may provide a compelling alternative to a REIT or REIT ETF investment.
As commercial real estate investing options, their names sound very similar, but there are important differences between REITs and REIT ETFs. Those differences are the subject of this article.
In the writing that follows, readers will learn what a REIT is, what a REIT ETF is, how they differ, and the pros and cons of investing in each.
First National Realty Partners is neither a REIT nor a REIT ETF, but we do offer a similar alternative in the equity portion of the capital stack. To learn more about our current investment offerings, click here.
What is a Real Estate Investment Trust ?
A Real Estate Investment Trust (REIT) is a company that buys, sells, operates, or finances real estate. REITs can be privately traded, which means that they are only available to accredited investors who meet certain income and net worth requirements. Or, they can be publicly traded, which means that their shares can be bought and sold on major stock exchanges by anyone with a brokerage account (NOTE: The discussion in this article focuses on publicly traded REITs).
Because each type of commercial real estate asset has their own operational quirks, REITs tend to specialize in specific property types like office buildings, healthcare buildings, data centers, self-storage, multifamily apartments, or retail shopping centers. For example, Prologis is a large publicly traded REIT that owns and operates industrial/warehouse properties and American Tower is a publicly traded REIT that specializes in communications infrastructure like cell phone towers.
For individual investors seeking exposure to commercial real estate, one of the challenges they may find with REITs is trying to choose which one to invest in. There are hundreds of public REITs, all of which are in pursuit of their own investment strategy. The number of choices can be overwhelming and filtering through them can feel like an impossible task. Enter the REIT ETF.
What is a REIT ETF?
To understand what a REIT ETF is, it is helpful to break this term into its two parts. A REIT is described above. ETF is an acronym for “exchange traded fund” is exactly what it sounds like. It is a hybrid product that combines the diversification of a mutual fund and the ability to buy and sell shares on a major stock exchange like a stock. ETFs are traded in real time at market prices while mutual funds are purchased through fund managers like Fidelity and Vanguard at share prices that are updated at the end of each day.
What Are The Differences Between REITs and REIT ETFs?
While both investment options have the same goal, to generate a return from commercial real estate investments. There are important differences that real estate investors should be aware of:
- Assets: REITs purchase and operate properties directly. REIT ETFs invest in shares of publicly traded REITs. For example, the Vanguard Real Estate ETF (Ticker: VNQ) is one of the largest REIT ETFs and their stated purpose is to ” track a market-cap-weighted index of companies involved in the ownership and operation of real estate in the United States.” Among the largest holdings in their portfolio are the aforementioned American Tower and Prologis. In short, REITs buy properties. REIT ETFs buy shares in REITs.
- Diversification: REITs diversify their portfolio through many properties, but within the same sector. REIT ETFs diversify their portfolio with many different REITs across many different property sectors. In short, they are more diversified.
- Asset Selection: REITs go through a rigorous due diligence process before purchasing a single property and they repeat it for each new investment opportunity. Depending on the strategy of the REIT ETF, the asset selection process may be much simpler. Many REIT ETFs go with a market weight strategy, which means that they just buy shares of REITs based on their market cap.
- Fees: Both REITs and REIT ETFs charge fees to real estate investors. The structure is typically unique to the specific asset so it is important for investors to understand it before making a purchase.
With these differences in mind, it is important to understand the pros and cons of investing in either of these asset classes.
Pros and Cons of REIT and REIT ETF Investing
While these two investment vehicles have material differences, the pros and cons of investing in them tend to be similar.
Both REITs and REIT ETFs offer investors the following potential benefits:
- Diversification: In their respective ways, both REITs and REIT ETFs provide investors with a level of diversification beyond what is available in the purchase of a single property.
- Income: Under IRS rules, REITs are required to pay out a certain portion of their income as dividends. Because REIT ETFs invest in REITs, they also tend to have a high dividend yield. In both cases, these dividends produce a steady stream of income for investors.
- Potential for Appreciation: Equity REITs and REIT ETFs are publicly traded, which means they also have the potential for price appreciation. In addition to dividends, this can potentially result in a high return relative to other options available in the stock market.
- Liquidity: Shares for both individual REITs and REIT ETFs can be bought and sold with ease. This provides a degree of liquidity not normally available in the real estate market.
- Inflation Hedge: Real estate tends to be somewhat of a safe haven during inflationary periods. This is because real estate rents (and prices) tend to rise in tandem with other prices. As a result, an allocation of capital to the real estate sector can prevent an erosion of purchasing power during periods of inflation.
Like any investment, there several risks to consider before allocating capital to a REIT or REIT ETF:
- Volatility: Because REITs and REIT ETFs are publicly traded, they can experience periods of significant price volatility, especially when the broader economy is going through economic distress. Price volatility can happen even if the fundamentals of the underlying real estate are sound.
- Interest Rate Sensitivity: Prices for both REITs and REIT ETFs tend to be highly sensitive to changes in interest rates. This is because, as their cost of capital rises, growth tends to slow.
- Taxes: Although there are a number of tax advantages to investing in commercial real estate properties through REITs and REIT ETFs, they can also produce a tax burden. Dividends are treated as taxable income and investors may be subject to capital gains taxes related to a profitable sale. The bigger the gain, the bigger the tax bill.
Given the pros and cons above, it would be logical for readers to ask, which is the better investment?
Which is The Better Investment?
When comparing two different potential investments, it can be tempting to try and figure out which one is better. The truth is that with REITs and REIT ETFs, neither one is an objectively better investment. But, one may be a better fit for an investor’s risk tolerance, return objectives, time horizon, and individual preferences. Potential investors should complete due diligence on all aspects of an investment opportunity and decide on the option that is most suitable for their unique needs.
How Do REITs and REIT ETFs Compare To Private Equity Investments
The focus of this article has been on the differences between REITs and REIT ETFs, but these aren’t the only vehicles through which to gain exposure to commercial real estate assets. Another option is the type of individually syndicated deal investments that we offer as a private equity firm. They differ from REITs and REIT ETFs in three key ways:
- Access: While publicly traded REITs and REIT ETFs are available to anyone. Private equity investments are only available to accredited investors, who can demonstrate compliance with SEC mandated income and net worth hurdles.
- Diversification: While REIT and REIT ETF investment portfolios are spread across hundreds of properties, an individually syndicated deal is for one property. While this does expose investors to increased diversification risk, it also gives them individual control over how their funds are invested. They can diversify their own portfolio by choosing which individual deals to participate in.
- Liquidity: While REITs and REIT ETFs provide a high degree of liquidity, private equity investments require a 5-10 year time commitment. While this may seem significant, it is ultimately beneficial because it gives the manager the time necessary to fully implement a property business plan.
For individuals who meet the minimum accreditation requirements and have a long term time horizon, an individually syndicated deal can provide a compelling alternative to a REIT or REIT ETF.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
Learn & Invest
The Ultimate Guide To Investing In Private CRE
The Comprehensive A-Z Guide Every Accredited Investor Should Read Before Investing in Private CRE Deals. Instant eBook Download. Updated for Q1 2021.Download Ebook
The Art of Commercial Real Estate
Learn from private equity fund managers how to become a top CRE operator and investor. True success requires an "it" factor. Find out if you have "it".DOWNLOAD NOW