What is the difference between real estate investment trusts and REIT ETFs?

REITs, trading on major exchanges, invest in real estate through mortgages or property. There are also privately and non-publicly traded REITs. Conversely, REIT ETFs invest most of the assets in equity REIT securities and other related derivatives. REIT ETFs trail indexes passively and offer low expense ratios.

There are three types of REITs: equity REIT, mortgage REIT, and hybrid REIT.

  • Equity REIT - This instrument invests in real estate properties and generate revenue on the rent received from the properties. Many equity REITs focus on commercial space, properties for healthcare, and storage spaces. Almost 90% of all REITs are comprised of equity REITs.
  • Mortgage REIT - It focuses in property mortgages. Such REITs may obtain mortgage-backed securities or offer mortgages to property owners. They earn money from the interest received on the mortgages or price appraisal in the MBS’ value.
  • Hybrid REITs - A combination of equity and mortgage REITs, hybrid REITs directly invest in properties and real estate mortgages. They belong to the smallest portion of the REIT sector.

REITs need not to pay income taxes, provided they adhere to certain federal regulations. As per tax rules, REITs must disburse at least 90% of taxable income annually to shareholders. At least 75% of the trust’s assets must either be in cash, real estate, or US Treasuries, while at least 75% of the income must come from loans, rents or other property investments. And most importantly, at least 100 shareholders must hold REIT shares.

Let us discuss some of the most popular REIT ETFs:

  • Vanguard REIT ETF - Being the largest REIT, it seeks stocks from REITs and mirrors the MSCI U.S. REIT index. VNQ, since it started trading in 2004, had more than $46 billion in assets under management and offers expense ratio of 0.12%. It also gives a 4% dividend payment and owns 145 stocks. Retail REITs had the biggest allocation of holdings at 24.8%, with 17 of its holdings in residential REITs and 16.7% in office REITs. VNQ accrued 8.67% for the three years prior to 2015 and rose 8.84% since then.
  • iShares U.S. Real Estate ETF - The derivative trails the Dow Jones US Real Estate Index. The second largest REIT ETF, it had $5 billion in management. IYR, since its inception in 2000, has 115 components and paid a 3.45% dividend. Its shares returned 7.6% for the three years prior to 2015 and earned 9.9% since its introduction.