Are REITs Closed-End Funds? Key Differences Explained
Demystify the structural and investment focus differences between REITs and Closed-End Funds for clearer investment understanding.
Many individuals seeking to invest in publicly traded vehicles often encounter a common question: are Real Estate Investment Trusts (REITs) the same as Closed-End Funds (CEFs)? While both investment types trade on stock exchanges, they possess fundamental distinctions in their underlying assets, structural requirements, and operational purposes. Understanding these differences is essential for investors.
What are Real Estate Investment Trusts (REITs)
A Real Estate Investment Trust, or REIT, operates as a company that primarily owns, operates, or finances income-producing real estate. These entities allow individual investors to gain exposure to large-scale real estate portfolios by purchasing shares, much like buying shares of any other company stock. REITs typically derive income from rents or real estate-related loans.
To maintain their specialized tax status, REITs must distribute 90% or more of their taxable income to shareholders as dividends. This allows REITs to avoid corporate income tax, with income taxed at the shareholder level, generally as ordinary income. Common REIT properties include apartment complexes, shopping centers, office buildings, data centers, healthcare facilities, industrial warehouses, hotels, and infrastructure like cell towers.
What are Closed-End Funds
A Closed-End Fund (CEF) is an investment company that issues a fixed number of shares to the public through an initial public offering (IPO). Once sold, the fund does not continuously create new shares or redeem existing ones, unlike open-end mutual funds. Instead, CEF shares trade on a secondary market, such as a stock exchange, where their price is determined by market supply and demand.
CEFs can invest in a broad spectrum of assets, including stocks, bonds, commodities, and real estate. Their fixed capital structure means portfolio managers do not face daily redemption requests, offering flexibility to invest in less liquid securities. Investors purchase and sell shares of CEFs among themselves, and the market price can trade at a premium or discount relative to the fund’s net asset value (NAV).
How REITs and Closed-End Funds Differ
The core distinctions between REITs and Closed-End Funds lie in their investment focus, legal and tax structures, share mechanisms, and regulatory oversight.
REITs are mandated to primarily invest in real estate assets, making them a direct vehicle for real estate exposure. In contrast, CEFs have a broader investment mandate, holding diverse portfolios encompassing equities, fixed-income securities, and other financial instruments.
Regarding legal structure and tax treatment, REITs operate as pass-through entities, avoiding corporate income tax by distributing at least 90% of their taxable income to shareholders. This income is generally taxed to the individual investor as ordinary income. CEFs are typically structured as regulated investment companies (RICs) under the Investment Company Act of 1940, with different underlying asset requirements and tax implications for investors.
The share structure also presents a notable difference. While both trade on exchanges, REITs can issue new shares over time to raise additional capital for new investments. CEFs issue a fixed number of shares during their initial public offering, which then trade exclusively on the secondary market. This fixed share count means a CEF’s market price can deviate significantly from its net asset value, trading at either a premium or a discount.
The regulatory framework also distinguishes them, with REITs adhering to specific Internal Revenue Service (IRS) rules to maintain their favorable tax status, and CEFs being regulated under the comprehensive Investment Company Act of 1940.