Equity REIT vs. Mortgage REIT

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Equity REIT vs. Mortgage REIT

Equity REITs and mortgage REITs are the two primary forms of real estate investment trusts (REITs) that investors may purchase. Mortgage REITs invest in mortgages and related assets, whereas equity REITs own and manage real estate.

What Is a REIT?

A REIT, which stands for real estate Investment trust, is a type of security in which the company owns and generally operates real estate or real-estate–related assets. REITs are similar to stocks and trade on major market exchanges. REITs allow companies to buy real estate or mortgages by using combined investments from a pool of investors. This type of investment allows large and small investors alike to own shares of real estate—without having to buy, operate, or finance real estate themselves.

REITs are generally required to have at least 100 investors, and regulations prevent what would otherwise be a potentially nefarious workaround: having a small number of investors own a majority of the interest in the REIT.

At least 75% of a REIT’s assets must be in real estate, and at least 75% of its gross income must be derived from rents, mortgage interest, or gains from the sale of the property.

Also, REITs are required by law to pay out at least 90% of annual taxable income (excluding capital gains) to their shareholders as dividends. This restriction, however, limits a REIT’s ability to use internal cash flow for growth purposes.

Key Takeaways

  • Companies that own, manage, or finance buildings that generate income are known as REITs.
  • Equity REITs own and manage real estate and generally rely on rental revenues for income.
  • Investments in mortgages, mortgage-backed securities, and associated assets are made by mortgage REITs, which also earn money from interest on these investments.
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Equity REITs

Equity real estate investment trusts are the most common type of REIT. They acquire, manage, build, renovate, and sell income-producing real estate. Their revenues are mainly generated through rental incomes on their real estate holdings. An equity REIT may invest broadly, or it may focus on a particular segment.

In general, equity REITs provide stable income. And because these REITs generate revenue by collecting rents, their income is relatively easy to forecast and tends to increase over time.

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Mortgage REITs

Mortgage REITs, commonly known as mREITs, invest in mortgages, MBS, and associated assets. Mortgage REITs make money through interest on their assets, while equity REITs often make money from rent.

Assume, for instance, that ABC Company is a REIT. With the money raised from investors, it purchases an office building and leases out office space. This real estate asset is owned and managed by Company ABC, which also charges rent to its tenants each month. Thus, Company ABC is regarded as an equity REIT.

Assume, however, that business XYZ qualifies as a REIT and loans money to a developer of real estate. In contrast to business ABC, company XYZ makes money from the interest on the loans. Therefore, Company XYZ is a mortgage REIT.

The bulk of mortgage REIT revenues are distributed to investors as dividends, much as equity REITs. In times of increasing interest rates, mortgage REITs often perform better than equity REITs.

Risks of Equity and Mortgage REITs

Equity REITs and mortgage REITs include risks, just like any other investment. Here are a few things that investors need to know:

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  • Equity REITs are often cyclical in nature and are susceptible to downturns in the economy.
  • In the case of equity REITs, excessive supply—for instance, more hotel rooms than the demand for them can bear—may result in greater vacancy rates and reduced rental revenue.
  • Earnings for mortgage REITs may be impacted by changes in interest rates. Similar to how more consumers may refinance or pay off their mortgages as a result of reduced interest rates, the REIT will have to reinvest at a lower rate.
  • The federal government backs the majority of mortgage securities that REITs purchase, which lowers the credit risk. However, depending on the particular investments, certain mREITs may be exposed to increased credit risk.

The Bottom Line

Without having to own, manage, or finance the properties themselves, REITs allow investors a means to participate in the real estate market. Equity and mortgage REITs must distribute 90% of their earnings to shareholders in the form of dividends, which are often greater than stock dividends.

In general, buy-and-hold investors seeking a mix of income and growth may find equity REITs appealing. Mortgage REITs, on the other hand, could be a better choice for risk-averse investors who are only interested in income growth.

What is real estate?

Real estate includes the land and any enduring features that are tied to it, whether they are created by nature or by humans. These features might include water, trees, minerals, structures, residences, fences, and bridges. Real property includes real estate. It is distinct from personal property, which includes items like cars, boats, jewels, furniture, and agricultural equipment that aren’t anchored to the ground.

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What is a mortgage-backed security (MBS)?

A mortgage-backed securities (MBS) is an investment that resembles a bond and is composed of a collection of mortgages that have been acquired from the banks who issued them. Periodic payments akin to bond coupon payments are made to MBS investors.

What is a trust?

In a trust, one person, known as the trustor, grants another party, the trustee, the authority to hold title to property or assets for the benefit of a third party, the beneficiary. This is referred to as a fiduciary relationship. Trusts are created to ensure that the assets of the trustor are legally protected, to ensure that the assets are transferred in accordance with the trustor’s desires, to save time, decrease paperwork, and, in certain situations, to avoid or minimize inheritance or estate taxes. A trust in finance may also be a particular closed-end fund created as a public limited company.

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