Understanding the Differences: REITs vs. REIT ETFs in Commercial Real Estate Investing
Written by Sean Shanahan | Learn More About Who We Are
When it comes to commercial real estate investing, two terms that often sound similar but have distinct differences are REITs (Real Estate Investment Trusts) and REIT ETFs (Exchange-Traded Funds). In this article, we will delve into what sets them apart, their unique characteristics, and the advantages and disadvantages of investing in each.
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What is a Real Estate Investment Trust (REIT)?
A Real Estate Investment Trust (REIT) is a company that engages in the acquisition, sale, operation, or financing of real estate properties. REITs can be privately traded, limited to accredited investors who meet specific income and net worth requirements, or publicly traded, allowing shares to be bought and sold on major stock exchanges. In this article, we will focus on publicly traded REITs.
REITs often specialize in specific property types, such as office buildings, healthcare facilities, data centers, self-storage units, multifamily apartments, or retail shopping centers. For example, Prologis is a publicly traded REIT that focuses on industrial/warehouse properties, while American Tower specializes in communications infrastructure like cell phone towers.
The Role of REIT ETFs:
For individual investors seeking exposure to commercial real estate, choosing the right REIT to invest in can be challenging due to the vast number of options. This is where REIT ETFs come into play. A REIT ETF is an Exchange-Traded Fund that offers both the diversification benefits of a mutual fund with the ability to buy and sell shares on a stock exchange. Unlike mutual funds, which have end-of-day share prices, ETFs are traded in real-time at market prices.
Distinguishing Features of REITs and REIT ETFs:
While both REITs and REIT ETFs aim to generate returns from commercial real estate investments, several key differences set them apart:
1. Assets: Owning Individual REITs allows an individual to choose specific real estate asset classes, while REIT ETFs will generally be a basket of assets. Both investments are shares of companies that enjoy certain tax advantages.
2. Diversification: REITs diversify their portfolios across multiple properties, while REIT ETFs offer broader diversification across a variety of REITs and property sectors.
3. Asset Selection: REITs conduct rigorous due diligence for each property acquisition, whereas REIT ETFs may employ a market weight strategy, buying shares based on asset type and performance.
4. Fees:REITs are required to pay out at least 90% of their taxable income as distributions. ETFs charge a fee to investors for asset management, generally .25-1%
Pros and Cons of Investing in REITs and REIT ETFs:
Investing in either REITs or REIT ETFs offers potential benefits and drawbacks, which are similar for both investment options:
Pros:
Diversification: Both REITs and REIT ETFs provide investors with diversification beyond individual property investments.
Income: REITs are required to distribute a portion of their income as dividends, and REIT ETFs, which invest in REITs, also offer high dividend yields.
Potential for Appreciation: Publicly traded REITs and REIT ETFs have the potential for price appreciation, allowing for potentially high returns.
Liquidity: Both individual REITs and REIT ETFs offer ease of buying and selling shares, providing liquidity not typically found in property level real estate investments.
Inflation Hedge: Real estate investments can act as a safe haven during inflationary periods.
Taxes: Dividends
Cons:
Volatility: REITs and REIT ETFs can experience price volatility, especially during economic downturns- Interest Rate Sensitivity: Prices of REITs and REIT ETFs are highly sensitive to changes in interest rates, as rising interest rates can slow growth.
Correlation: REITs and REIT ETFs can have strong correlation with the overall stock market, even if the underlying real estate fundamentals are sound.
Choosing the Right Investment:
Deciding between REITs and REIT ETFs depends on an investor's risk tolerance, return objectives, time horizon, and individual preferences. There is no objectively better investment option, and thorough due diligence is crucial before making a decision.
Private Equity Investments as an Alternative:
In addition to REITs and REIT ETFs, private equity investments offer another avenue to gain exposure to commercial real estate assets. These individually syndicated deals differ from REITs and REIT ETFs in terms of access, diversification, and liquidity. While private equity investments require accreditation and a longer time commitment, they provide individual control over investment choices and the opportunity to diversify through selecting specific deals.
Understanding the differences between REITs and REIT ETFs is essential for investors considering commercial real estate opportunities. Both options offer advantages such as diversification, income generation, potential appreciation, liquidity, and inflation hedging, but they also carry risks. By evaluating personal investment criteria and considering alternatives like private equity investments, investors can make informed decisions aligned with their goals and preferences.
