May 19, 2021

REIT vs Real Estate Fund (Differences + How To Invest)

Aside from the fantastic passive income they generate, real estate investments are also great for diversification and act as a hedge against inflation. 

The downside is that making a real estate investment has historically been tricky and expensive.

However, thanks to advances in technology and finance, investments like real estate are now becoming much more accessible to everyday investors. 

Two perfect examples of this are the development of REITs and real estate funds.

But, what are REITs and real estate funds? What's the difference between a REIT vs real estate fund,  and what are some things you should be aware of?

In this guide, we’ll answer those questions and show you how you can take advantage of these opportunities.

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What Is A REIT?

A REIT, or real estate investment trust, is a company that typically owns and operates income producing real estate. 

REITs can own various types of real estate asset holdings, including warehouses, office and apartment buildings, hospitals, shopping centers, and more. However generally, most REITs tend to focus on a single sector of real estate.

REITs are structured similarly to mutual funds in that investors pool their capital with other investors to buy a share of real estate. Investors then benefit from the rental income they earn through dividend payments and through capital appreciation of the underlying asset. 

There are two main types of REITs:

  • Equity REIT: owns and manages the properties.
  • Mortgage REIT: lends money to real estate owners and operators.

For a company to be considered a REIT, they have to meet specific criteria first. 

Two of these criteria are: 

  • A REIT must invest at least 75% of its assets in real estate and must derive a minimum of 75% of its income from real estate investments.
  • REITs must pay at least 90% of their taxable income to shareholders through dividends every year.

A public REIT is the most well-known kind of REIT. A publicly traded REIT trades on major stock exchanges while a public non traded REIT is a REIT that isn't traded on exchanges but is still open for anyone to invest in. 

Finally, a private REIT is one that’s not available to the public and functions like real estate private equity. You can also invest in a hybrid REIT, which is often a combination of different types.

What Is A Real Estate Fund?

A real estate fund is a professionally managed portfolio of diversified holdings, typically focusing on a form of commercial or corporate rental property. Real estate funds can also invest, either directly or indirectly, into domestic or international REITs. 

Real estate funds can take the form of an ETF (exchange-traded fund), a mutual fund, a private real estate fund like private equity, or a hedge fund. 

Real estate mutual funds and ETFs are actually very similar investments. 

Both work by pooling investors’ money and purchasing a diverse range of stocks, in this case, REITs. While mutual funds are priced daily and don’t trade on stock exchanges, a REIT ETF trades like an individual stock, with its price fluctuating while the market is open.

One of the best examples of a real estate fund is the Vanguard Real Estate Index Fund (VGSLX). The Vanguard REIT fund is available as both an ETF and mutual fund. It invests in 183 different REITs that buy office buildings, hotels, self-storage facilities, data centers, and more.

Real estate funds allow everyday investors to participate in the profits of large commercial real estate companies while providing the usual benefits associated with mutual funds like easy accessibility.

REIT Vs. Real Estate Funds: What Are The Differences? 

While REITs and real estate funds share some similarities, there are a few differences. 

A. Direct vs. Indirect investments

One of the biggest differences between a REIT vs real estate fund is that investing in REITs means you’re investing directly into a piece of real estate. In contrast, a real estate fund mirrors a traditional mutual fund, investing in securities offered by real estate companies. 

In other words, REITs are a direct investment into real estate. In contrast, real estate funds may invest in REITs and stocks in a real estate company, they do not typically invest in physical real estate.

B. Investment Minimums

REITs and real estate funds also have different investment minimums. Since REITs are affordable for everyday investors entering the real estate market, investment minimums usually start at a few dollars and shouldn’t cost more than a few hundred dollars.

It’s important to note that real estate ETFs have investment minimums comparable to those of REITs. However, real estate mutual funds tend to have higher minimums, usually not more than $10,000. 

C. Returns

Since REITs must pay out 90% of their taxable income to shareholders through dividends, this is often the primary way REIT investors earn.

While real estate funds can also offer good returns, there are often multiple fees associated with them that can take a chunk out of your earnings. This is especially true for real estate mutual funds as they’re actively managed. 

REITs are also the better option for investors looking for passive income generation. 

Pros And Cons Of Investing In Reits And Real Estate Funds

Both real estate investing opportunities offer great benefits, but each one comes with its own set of drawbacks.

Here’s a look:

Advantages of REITs

REITs are a fantastic investment opportunity that offers a few notable advantages: 

  • REITs allow an individual investor to benefit from real estate without large investment minimums, making them highly affordable compared to direct real estate investing.
  • REITs provide above-average returns through real estate property rent. They also have fantastic long-term growth potential since real estate often appreciates over time. From 2000 to 2020, the FTSE NAREIT All Equity Index, which tracks all 12 REIT sub-sectors, has provided a total annual return of 13.3% v.s. the S&P 500’s 7.7%.
  • REITs can generate passive income.
  • If most of your investments are in stocks and bonds, investing in a REIT is excellent for providing risk-adjusted returns since typically a REIT shares a low correlation with stocks.

Disadvantages of REITs

Before deciding to invest in a REIT, keep the following points in mind: 

  • Investing in a REIT means having to spend the time researching and evaluating individual REITs to find one that suits your financial goals.
  • Many REITs focus on one specific category of real estate, so diversification may be an issue. For example, the COVID-19 pandemic resulted in a 15% drop across the real estate sector as a whole in 2020 through mid-June. However, if you had invested specifically in hotels or retail REITs, your investment would have dropped by 50%.
  • Liquidity risk is an ever-present issue. It refers to the risk that the REIT may need to sell assets at a lower price to compensate for poor cash flow or cover ongoing expenses, such as maintaining the investment property.

Advantages of real estate funds

Real estate funds have several benefits such as: 

  • Real estate funds offer certain tax benefits. Many mutual funds are structured to last longer than one year, meaning they benefit from long-term capital gains tax. For most taxpayers, the long-term capital gains tax is 15%, whereas short term capital gain tax is 37%.  On the other hand, the income a real estate investor receives through dividends from REITs is taxed as ordinary income. This can range from a minimum of 10% to a maximum of 37%, depending on your level of income.
  • Many funds will target more than one asset class and geographic location. Doing so can shield your portfolio from being adversely affected by industry-specific trends.
  • Real estate funds are fantastic for diversification. Since funds invest in a portfolio of related securities, you gain access to lots of different assets. This also helps shield your investments when the market is underperforming.

Disadvantages of real estate funds

A few points to keep in mind before investing in real estate funds are:

  • Perhaps the biggest downside of real estate funds is their additional expenses. Being actively managed means you’re likely going to have ongoing fund manager fees that can take a chunk out of your potential earnings. This is especially true for private real estate funds.
  • Real estate funds don’t give you the opportunity to actually own a chunk of real estate. You’re simply investing in companies or trusts that do.

To sum up, both real estate funds and REITs offer you tons of advantages and are far more affordable than direct real estate ownership. However, both come with a few specific drawbacks.

However, if you’re looking for an easy and affordable way to actually own a piece of real estate without all the hassle associated with land-ownership, REITs are the way to go. With that said, here are a few good REITs to consider investing in:

3 Fantastic REITs To Invest In

Here are three great REITs to consider: 

1. Modiv

Modiv is a US-based real estate, fintech, and proptech asset manager dealing in non-traded REITs. 

Currently only open to accredited investors, Modiv works by raising funds on the platform before acquiring single-tenant net lease (STNL) properties. This ensures that the properties generate a steady income.

Potential returns

Modiv targets annual returns of 7% to 12%. 

Minimum investment

$1,000.

Fees

There are no fees charged to investors.

2. Fundrise 

Fundrise is the largest direct-to-investor real estate platform in the US. Investments work by selecting one of Fundrise’s five core accounts, each with different goals and strategies.  

Fundrise has developed its own take on the traditional REIT, called the eREIT, designed to be low-cost and tax-efficient. It incorporates both debt and equity instruments. 

Potential returns

Fundrise gears all its investments for the long term. However, between 2014 and 2020, investors earned average annual returns ranging between 7.4% and 12.4%.

Minimum investment

$500.

Fees

There’s a 0.85% annual asset management fee and a 0.15% annual investment advisory fee. There are no transaction fees.

3. Concreit

Concreit is a real estate investment app allowing investors to invest in a diversified portfolio that targets private loans backed by real estate and fractional shares of multi-family real estate in the United States.  

Potential returns

Concreit targets annual returns of between 5% and 8%. 

Minimum investment

$1. 

Fees

There’s an annual Assets Under Management (AUM) fee of 1%. There are also withdrawal and redemption fees depending on how long you’ve held the assets.

Final Thoughts

Both REITs and real estate funds offer numerous advantages. They can provide solid potential for long-term growth and offer excellent portfolio diversification, though neither is without risks.

If you’re looking for other similar investment opportunities, such as investing in farmland or neighborhoods, take the MoneyMade Investor Quiz. Answer a few easy questions about your investment preferences, and MoneyMade will generate a list of investment solutions that suit your unique needs!

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