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

Equity vs. Mortgage REITs: An Overview

There are several different types of real estate investment trusts (REITs) including equity REITs, mortgage REITs, and hybrid REITs. A REIT 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 their investors. This type of investment allows large and small investors to own a share of real estate.

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

Key Takeaways

• REITs are share-like securities that allow large and small investors to add real estate ownership 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’ revenues are mainly generated from rental incomes from their real estate holdings. Equity REITs typically invest in office, industrial, retail, residential, hotel, and resort properties.

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

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

Note

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

Mortgage REITs

Mortgage REITs invest in mortgages only, and they make up a small share of the REIT market. While equity REITs typically generate their incomes from renting out real estate, mortgage REITs mainly generate their revenues from the interest earned on their mortgage loans. They also trade and invest in 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 to investors as dividends. Mortgage REITs tend to perform better in times of rising interest rates. However, like equity REITs, there are so many different target markets that mortgage REITs almost always have investment opportunities available.

Hybrid REITs

Hybrid REITs invest in both properties and mortgages. By investing in both mortgages and hard assets, hybrid REITs take a more balanced approach and may be able to profit in both rising and falling interest-rate environments where traditional equity-only or mortgage-only REITs can 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 allows them exposure to real estate properties without having to directly own property. REITs are required by law to pay out at least 90% of their income as dividends, making REITs a good contender for stable income payments.

How Do I Invest in a REIT?

You can invest in a REIT by purchasing one in your brokerage account. You will need to open a brokerage account first, such as E*Trade, deposit funds in the account, and purchase a publicly traded REIT like you would a stock. Before purchasing a REIT, make sure you perform research on the specific REIT to determine if it meets your investment goals and risk tolerance.

What Is the 90% Rule for REITs?

The 90% rule for REITs states that by law, REITs must pay out 90% of their income as dividends to investors annually. For investors, this ensures a consistent income payment, and for REITs, this keeps taxes low, allowing for 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 come with different investment opportunities. Equity REITs generate income through rent while mortgage REITs generate money from loans and mortgage-backed securities (MBS).

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