Types of REITs
By Tam Ging Wien
There are 2 main categories of REITs, namely Equity REITs and Mortgage REITs.
Equity vs Mortgage REITs
Equity REITs source, acquire, own and manage income-producing real estate assets.
Some REITs specialised in a specific real estate sector while others could have broad portfolios that spans across a multiple real estate sectors. They could also own assets in one region or span across a wide geographic coverage. Real estate sectors are typically classified into the following categories, each with their own unique economics and characteristics:
Equity REITs typically work by raising funds from shareholders through an initial public offering (IPO) and using those funds to acquire a portfolio of income-producing real estate assets. These assets are then leased out to tenants to earn a steady stream of rental income. The revenue stream from these rentals are used to pay the various expenses of the REIT before it is distributed back to shareholders in the form of regular dividends. Equity REITs may from time to time rebalance their portfolios by acquiring new assets to grow their income or divesting existing assets to lock in profits.
The objective of an Equity REIT is to increase shareholder value through the long-term capital appreciation of its real estate portfolio as well as by growing its dividend stream through higher rental reversions.
Mortgage REITs on the other hand lend money in the form of mortgages to real estate purchasers. They may also buy existing mortgages or mortgage-backed securities issued by other lenders or sell them to other investors. Their revenue is primarily generated by the interest that they earn on their mortgage loan portfolio.
Mortgage REITs typically use a combination of their internal funds and assets to borrow money at low short-term interest rates. The monies are then used to invest in real estate backed mortgages that pay higher long-term interest rates. Mortgage REITs earn a profit from the different between their mortgage interest income and borrowing cost – this difference is known as the spread.
Mortgage REITs are extremely sensitive to interest rate fluctuations
As short-term interest rates are volatile and have a direct impact on the cost of mortgages, Mortgage REITs tend to react more quickly to changes in the interest rate environment Equity REITs – in other words, Mortgage REITs are extremely sensitive to interest rate fluctuations. If short-term interest rates spike, the spread would narrow resulting in diminished profits for the mortgage REIT. On the other hand, when interest rates plunge, the spread would widen providing the REIT with a large profit margin.
As most Mortgage REITs leverage to boost their returns, they can be incredibly volatile compared to Equity REITs. Investors should understand that the characteristics of both types of REITs defer widely both in terms of how they work as well as their investment risk, predictability and volatility.
Some REITs are a hybrid of both categories and own both real estate assets as well as real estate backed mortgages.
Listed vs Non-Listed REITs
The most popular REITs that investors are familiar with are REITs that are publicly listed and traded on major stock exchanges. However, there are also non-listed REITs which are typically setup by private funds and marketed directly to investors.
For listed REITs, investors can buy or sell them quickly as they are traded over an exchange and are therefore said to be more liquid – a term used to describe the ease of converting the shares to cash. However, they are also more volatile as their prices fluctuate on a daily basis based on the demand and supply of their shares on the exchange.
Non-listed REITs on the other hand tend to be less liquid due to fewer transactions on their shares, and hence less volatile. However, the illiquidity means that finding a buyer for your shares may be more difficult and may take a much longer time.
REITScreener primarily focuses on listed REITs.