REIT vs Real Estate Fund: Key Differences Explained

Among various options available to the investors when it comes to real estate investing are REITs and real estate funds. Both are popular in accessing the lucrative market of real estate without the hassle that comes with owning properties themselves. Yet, they differ significantly in structure, purpose, and risk profiles. Let’s find out the key differences between REIT vs real estate fund to help you make an informed judgment as to which option best fits your particular investment objectives.

Table of Contents

What is REIT?

• Types of REITs
• Advantages of Investing in REITs
• Disadvantages of Investing in REITs

What is a Real Estate Fund?

• Types of Real Estate Funds
• Advantages of Investing in Real Estate Funds
• Disadvantages of Investing in Real Estate Funds

Key Differences Between REITs vs Real Estate Funds

• Investment Approach
• Liquidity
• Income Generation
• Tax Implications
• Risk and Return Profiles
• Fees and Expenses

How To Choose the Right Option For You

The Bottom Line

FAQs

What is REIT?

A Real Estate Investment Trust (REIT) is an organization or company that manages, invests in, or provides funding for properties that generate income. As set up, these publicly traded entities offer the investor an opportunity to take part in the real estate market without necessarily owning or managing a property. They typically invest in a range of real estate assets, including office buildings, shopping centers, apartment complexes, healthcare facilities, and logistics centers.

In countries like the United States, the definition of REITs makes the distribution of at least 90% of their regular income as dividends to its shareholders mandatory. This allows a stream of periodic income for the investors and, simultaneously, a good tax advantage since it would not be subject to corporate income taxes for the earnings distributed.

Types of REITs

1. Equity REITs 

They predominantly specialize in ownership and operation of income-generating property. In equity REITs, the revenues are collected in the form of the properties' rents, as their strategies for long-term capital appreciation are developed. For example, an equity REIT specializing in retail may own shopping malls or strip centers.

2. Mortgage REITs 

Mortgage REITs invest directly in real estate financing. They originate or purchase mortgage-backed securities, making a profit from the spread between the rates at which they borrow and lend. 

3. Hybrid REITs 

Hybrid REIT is the combination of equity and mortgage REITs. They invest in real properties and also in debt instruments, therefore providing a combination of rental income and interest-based revenue. Curious about how REITs compare to owning rental property directly? Check out our in-depth article: REIT vs. Rentals. 

4. Private REITs 

A private REIT is not traded on public stock exchanges but offered directly to a select group of accredited investors. Private REITs operate under Regulation D of the Securities Act, which exempts them from many of the disclosure requirements applicable to public REITs.

Advantages of Investing in REITs

1. High dividend yields
   REIT investors may enjoy consistent, above-average dividends due to the mandatory distribution of 90% of the taxable income.
2. Diversification benefits
   REITs allow diversification of the portfolio into the real estate sector without the hassle of directly owning a property.
3. Professional management
   REITs are professionally managed companies that save investors from the stress of active management.
4. Liquidity
   Publicly traded REITs are listed on major exchanges, thus offering an investor a liquid avenue of purchase and sale.

Read more: How to Invest in REIT funds

Disadvantages of Investing in REITs

1. Sensitivity to interest rate fluctuations
   REITs are sensitive financially to changes in interest rates. For instance, with rising interest rates, their cost of borrowing increases, making them a less appealing investment. 
2. Exposure to real estate market risks
   Just like all the rest, REITs are as good as any other real estate investment and are therefore susceptible to market-specific risks such as declining property values or reduced demand within specific sectors, which adversely affect returns. 

What is a Real Estate Fund?

A real estate fund is an investment through which many investors pool capital into one portfolio comprising assets. As opposed to REITs, the arrangement of real estate funds commonly takes the form of a mutual fund or a private equity fund that invests in a wide array of securitized and unsecuritized real estate, which also covers physical properties. Real estate funds may specialize in property stocks, REITs, or even directly in residential, commercial properties, and industrial houses and buildings.

Real estate funds present investors with an indirect route to the real estate market, besides the added plus of professional management of those funds. They have much more flexibility in the matter of asset allocation. They are allowed to shift investment if the market conditions or strategic reason warrants it. This expertise often comes with a price tag, higher management fees compared to many other vehicles.

Types of Real Estate Funds

1. Equity Funds Focused on RE Stocks and REITs 

These funds invest majorly in companies in the real estate industry, like REITs and property firms. They realize growth and passive income from securities.

2. Sector-Specific Funds 

Sector-specific funds will be set up to focus on a specific type of real estate, such as residential, commercial buildings, or industrial warehousing. 

3. International Funds 

International real estate funds expose domestic investors to foreign real estate markets. Real estate investments can be used in their geographical diversification in order to benefit from the growth of an emerging or developed international economy.

Advantages of Investing in Real Estate Funds

1. Potential for high returns
   Through strategic investment in a wide array of assets, these funds can achieve potentially much higher returns, especially in high-growth markets or niche sectors.
2. Diversification benefits
   Real estate funds diversify the investment across various properties, sectors, and regions to minimize risks of market fluctuations or sector-specific downturns.
3. Access to exclusive deals
   Private real estate funds will enable investment opportunities that may be unreachable by individual investors, like getting properties off-market or substantial large-scale development projects. Read our comprehensive guide on how to invest in private equity real estate to discover strategies and tips for getting started.

Disadvantages of Investing in Real Estate Funds

1. Lower liquidity
   Real estate funds, especially private equity funds, are illiquid investments compared to publicly traded REITs. There may be certain restrictions as to when and how much money investors can take out.
2. Higher fees
   The professional management and active strategies of real estate funds often come with higher fees which can eat into overall returns.
3. Potential for illiquidity risk
   Some real estate funds invest in assets that take longer to sell, thus liquidity risks are passed to the investor in the event of market decline.

Key Differences Between REITs vs Real Estate Fund

Understanding the key differences between REIT vs real estate fund is important for investors to proceed with informed investment decisions and align such with their financial goals.

Investment Approach

The major difference between REIT vs real estate funds is the way they approach the real estate market. REITs are all about the direct ownership of income-generating real estate assets, including office buildings, residential complexes, etc. These companies will acquire, manage, and lease properties to give passive investors direct exposure to real estate income streams.

In return, real estate funds pool investors' capital to invest in a wide array of real estate-related securities and assets. Such funds may contain REIT stocks, real estate bonds, or actual properties.

Liquidity

One of the features defining REITs is liquidity. Publicly traded REITs are usually on major exchanges. Just like common stock, investors can readily buy and sell their shares of REITs. 

Real estate funds generally lack the same liquidity. Shareholders' ability to redeem primarily depends on the respective REIT's policy, besides the regular redemption offer which usually has constraints. Some funds may allow direct drawing, though normally including limitations such as lock-up or less frequency than usual redemption limits.

Income Generation

REITs are bound to distribute at least 90% of their taxable income to shareholders. This is in the form of regular dividend payments. That again will ensure regularity and potential high yield dividend payouts.

On the other hand, real estate funds might provide a mix of passive income through dividends and capital gains appreciation on the various assets held. The income generated from the funds is generally less predictable than that coming from REITs since it is tied to the performance of the underlying assets and the strategy adopted by the fund manager himself.

Tax Implications

Dividends from REITs are usually taxed as ordinary income, with limited exceptions that may qualify for specific deductions. This can result in a higher tax burden on the investor in higher tax brackets.

On the other hand, though real estate funds earn income in forms such as dividends and capital gains, the latter more often than not has the benefit of being taxed at long-term capital gain rates. Private real estate funds may offer numerous tax benefits to their investors in forms such as depreciation benefits.

Risk and Return Profiles

REITs may pay consistent dividends but their share prices also follow the broader market's ups and downs. They are also directly linked with the performance of the real estate sectors they are into, be it retail or healthcare.

The investment portfolio of real estate funds tends to be more diversified. In most cases, this increased diversification comes at a cost: lower predictability of income and potentially poor liquidity, especially with regard to private real estate funds.

Fees and Expenses

Most of the time, REITs carry lower fees and expenses compared to real estate funds. Publicly traded REITs function just like other types of stocks, with minor transaction costs and no management fees to the investor. Additionally, REITs generally have low to zero minimum investment requirements.

Real estate funds, primarily private equity investing, tend to charge higher management and performance fees and higher minimum investment. These additional costs can dampen potential returns, and the investor has to consider that fact before putting their money into the fund. 

How to Choose the Right Option for You

When investing in REIT vs real estate funds, there are a number of important factors to consider in order to ensure that an investment aligns with financial goals and a personal situation. 

1. Risk Tolerance Level:  If you like low-risk investments with potential steady income, REITs are perhaps the best. While REITs trade in the public markets, it may be subject to some market volatility. Real estate funds provide a diversified avenue where risks are spread across several asset types.
2. Time Horizon: A shorter time horizon or a flexible one would be best met by REITs due to their public trading features that can be liquidated any time with ease. In real estate funds, many, if not all, come with a longer lock-up period. 
3. Liquidity Needs: REITs are liquid because they could be purchased or sold in stock exchange anytime during open hours.
4. Fee Sensitivity: REITs typically have lower costs for investors, as they operate similarly to traditional stocks with minimal transaction fees. Real estate funds have higher management and performance fees, especially in private equity structures.
5. Tax Implications: Most of the dividends you gain with REITs are usually considered ordinary income and can be burdensome for investors in higher-income brackets. It is best to consult with an investment advisor on which one fits your tax strategy. 

The Bottom Line

It’s always essential to know the difference in characteristics between a REIT vs real estate fund in order to align them with your financial objectives, risk tolerance level, and investment horizon. REITs provide a simple, liquid manner of accessing real estate income, often fitting for income-oriented and fee-sensitive investors. On the other hand, real estate funds provide diversification and access to exclusive real estate opportunities but may require a longer commitment and come with higher fees. Both options can play an important role in your diversified portfolio, depending on your specific needs and priorities.

FAQs

Can a real estate fund include REITs in its portfolio?

Yes, real estate funds can include REITs in their portfolio. Many equity-focused real estate funds invest in REIT stocks to attain exposure to income-generating properties while maintaining liquidity and diversification.

Which is better for long-term growth: REITs or Real Estate Funds?

Real estate funds are more suitable for growth in the long term, considering diversified investment strategies and long-term capital appreciation. REITs do ensure steady income, but have less potential for growth compared to funds that strategically reallocate their assets across sectors or geographies.

Are REITs or Real Estate Funds more suited for retirement income?

REITs may be more appropriate for retirement income, as they boast steady and high dividend yields that will help retirees generate passive income with better reliance than a real estate fund focused on capital gains, which could take longer to realize.

What is the difference between REIT and mutual fund?

REIT operates income-producing real estate and distributes earnings, after corporation tax deductions for income, to the investors in the form of dividend income. A mutual fund pools money from investors to invest in a diversified portfolio that may include REIT stocks or bonds. Therein lies the principal distinction: REITs only relate to real estate, while the portfolios of mutual funds are essentially diversified.

What are the differences between REITs and real estate crowdfunding?

REITs are publicly traded. Therefore, investors can invest in them through the stock exchanges. Real estate crowdfunding means that pooled funds are being directly invested in certain properties or projects by a pooling of funds by a number of people, generally through online platforms.