Fundamental Differences Between Equity REITs and Debt REITs
According to Forbes, many financial advisors recommend that investors maintain diversified sources of income in retirement, regardless of the size of their nest egg. Retirees typically live on a fixed income that is funded by a combination of investment income and withdrawals of principal.
Investing in Real Estate Investment Trusts (REITs) may provide retirees and individuals who have similar objectives with high yields, diversification, and a potential income stream. Oftentimes, retirees are dividend investors who have conservative investment goals. They may not worry about outperforming the market, but instead may be focused on generating and accumulating income while preserving and protecting their capital.
Traditionally, CNBC reports that retirees have focused on investing in large cap equities and bonds as their primary source of investment income. Real estate may provide retirees with an alternative source of income via potential dividends. Real estate accessed through Real Estate Investment Trusts (REITs) include equity REITs and debt REITs (also known as mortgage REITs). Below we identify the some of the key differences and similarities between the two types.
Equity REITs and how they work
Equity REITs make investments in and acquire properties across the spectrum of commercial real estate, ranging from shopping centers to hotels to office complexes to apartments. Their revenues may be generated from the rent they collect from tenants and businesses who lease the spaces. Additionally, ownership of real estate may lead to price appreciation, which may lead to an increased value of holdings.
For example, assume Company A qualifies as a REIT. It purchases an apartment building with funds raised from investors and leases out the space until the property is fully occupied. Company A now owns and manages this real estate property and collects rent every month from its tenants. Company A is considered an equity REIT.
Equity REITs may specialize in owning certain property types such as apartments, shopping centers, office buildings, or self-storage facilities. Some equity REITs are diversified and may own multiple types of properties.
Once a REIT has covered its offering, organizational and operating costs associated with running its properties, equity REITs must pay at least 90% of the income they collect to their shareholders in the form of dividends, which may be distributed on a monthly or quarterly basis.
Debt or Mortgage REITs and how they work
Contrary to equity REITs, mortgage or debt REITs lend money to real estate buyers in the form of debt or debt-like instruments which may include first mortgages, mezzanine loans, and preferred equity structures. While equity REITs typically generate their potential income from rents, debt REITs generate their revenues from the interest earned on the debt instruments. Like equity REITs, mortgage REITs are required to distribute at least 90% of their annual taxable income to shareholders. However, unlike equity REITs, debt REITs do not benefit from the property’s potential price appreciation.
For example, assume Company B qualifies as a REIT and makes a loan to a real estate sponsor. Unlike Company A, Company B generates potential income from the interest earned on the loans. Therefore, Company B is a mortgage, or debt REIT.
Debt REITs own no physical property, but instead invest in property mortgages. These REITs loan money for mortgages to owners of real estate or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.
Both equity REITs and mortgage REITs may be listed on major stock exchanges, but they may also be traded privately. Of the two, NAREIT reports that equity REITs are more common, accounting for a majority of the U.S. REIT market. According to NAREIT, equity REITs own more than $2 trillion of real estate assets in the U.S., including more than 200,000 properties in all 50 states and the District of Columbia. This means that there are fewer mortgage REITs, which are secured by real estate but do not generally own or operate the underlying real estate.
Risks of investing in REITs
While investing in REITs may offer diversification and attractive yields, there are inherent risks. Not all REITs trade on a public exchange, and those that do not are considered illiquid investments. Investors who buy shares of non-listed REITs run the risk of being unable to sell off their shares quickly and at their current price.
Furthermore, it can be difficult to gauge the value of non-public REITs, as valuations are not as frequent as public REITs, and are oftentimes reported quarterly, rather than daily. Additionally, many non-public REITs come with hefty up-front fees. For these reasons, investors should weigh all the advantages and disadvantages before deciding to invest in a REIT.
Before investing, consider the “Risks” associated with each investment. Important information about risks, fees and expenses are outlined in the official offering documents. Investing in REIT common shares is speculative and risks include, illiquidity, complete loss of capital, limited operating history, conflicts of interest and blind pool risk.
Benefits of investing in REITS
One benefit of investing in REITs is that they may offer high dividends, as they are required by the IRS to distribute at least 90% of their annual taxable income to shareholders. This means that REITs are not allowed to retain most of their profits to fuel their own growth. As such, they are designed for investors with the goal of a potential income stream.
Another benefit of investing in REITs is that they are designed to offer a degree of diversification. REIT investors may add real estate to their portfolios without the workload of buying an actual property or group of properties, by buying REITs located in multiple geographies and invested in a range of property types.
Access to equity and debt REITs
At RealtyMogul, we offer both equity and debt REITs on our platform. Our non-traded REITs invest in portfolios of commercial real estate properties across the United States:
MogulREIT I invests in a variety of commercial properties via debt and debt-like securities. The primary objectives of MogulREIT I are to pay attractive and consistent cash distributions, and to preserve, protect and increase an investor’s capital contribution.
MogulREIT II invests in common equity and preferred equity in multifamily apartment buildings throughout major markets in the United States. The primary objectives of MogulREIT II are to realize capital appreciation in the value of our investments over the long-term, and to pay attractive and stable cash distributions to shareholders.
Investing in the common shares of the REITs is speculative and involves substantial risks. The “Risk Factors” section of the offering circular contains a detailed discussion of risks that should be considered before you invest. These risks include, but are not limited to illiquidity, complete loss of capital, limited operating history, conflicts of interest and blind pool risk. MogulREIT I’s investments may be limited in assets or concentrated in a geographic region posing additional risks from natural disasters, economic downturns, and competition from other properties. MogulREIT II’s multifamily investments can be subject to specific risks including, changes in demographic or real estate market conditions, resident defaults, and competition from other multifamily properties.
All information provided herein is solely informational and not an offer or solicitation of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice and should not be relied upon to make an investment decision. This may contain forward-looking looking statements and projections that are based on current beliefs and assumptions we believe to be reasonable. Such statements involve risks and uncertainties with investing and nothing is guaranteed.