Real estate investment trusts are powerful tools for investors and financial professionals looking to gain exposure to real estate without directly owning properties. Understanding the difference between an equity and mortgage REIT is vital, as these two types of REITs serve distinct purposes within the real estate market. Read on to explore helpful information to empower work with clients.
Defining a REIT
First off, there are many different types of REITs. Equity and mortgage REITs are two of the main categories that often get confused. At their core REITs are companies that own (and usually manage) income-generating real estate. They allow investors to pool their capital, providing a way to access real estate markets without needing to purchase properties outright.
Congress created REITs in 1960 to democratize access to real estate investments. To qualify as a REIT, a company must meet specific criteria, such as paying at least 90 percent of its taxable income in dividends to shareholders and earning most of its income from real estate investments.
A Look at Equity REITs
Equity REITs focus primarily on owning and managing physical income-producing properties. These might include office buildings, retail centers, apartments, industrial warehouses, and other commercial spaces. Equity REITs generate the majority of their income through rental payments. They provide mortgage professionals and investors with a more direct tie to the real estate industry by reflecting the value of tangible assets.
Equity REITs often serve as a hedge against inflation, as rent rates tend to rise with inflationary pressures. As a result, the returns they offer remain relatively stable over market cycles, making them a dependable investment option.
A Breakdown of Mortgage REITs
On the other hand, mortgage REITs (or mREITs) don’t entail the ownership of physical properties. Rather, they capitalize on real estate–related debt, such as mortgage-backed securities or the actual loans themselves.
Mortgage REITs earn profits by collecting interest on these financial instruments, capitalizing on the spread between borrowing costs and lending rates. These REITs provide liquidity within the mortgage market.
Mortgage professionals will note that mREITs are sensitive to interest rate fluctuations, which can influence their profitability. However, this sensitivity can also make them appealing during times when rates are more predictable.
Moreover, REITs have done a good job under pressure in recent years, which spells good news for investors during uncertain economic times. Finally, while mortgage REITs are potentially more volatile than equity REITs, they often yield higher dividends due to their investment strategy.
Combining the Two in a Hybrid REIT
Hybrid REITs blend the strategies of equity and mortgage REITs, offering exposure to both property ownership and real estate debt. These REITs invest in a combination of assets, including physical properties and mortgages or mortgage-backed securities.
This diversification can balance the benefits and risks associated with each REIT type, providing versatility for investors and clients. You might suggest or employ hybrid REITs to achieve a middle ground that doesn’t make you choose between tangible assets and financial instruments. While hybrid REITs may not perform as strongly as specialized REITs in specific markets, they offer resilience across broader market conditions.
Understanding the difference between an equity and mortgage REIT allows mortgage professionals like yourself to better guide clients in making informed investment decisions. Each REIT type serves a purpose, and with proper knowledge, you can help your clients harness the power of real estate investments.
