Are REITs ETFs? Key Differences for Investors

Investing in real estate can seem complicated, but understanding different investment vehicles can simplify the process. Real Estate Investment Trusts (REITs) and Exchange Traded Funds (ETFs) are two common investment options that allow individuals to gain exposure to various asset classes. While both can be part of a diversified portfolio, they represent different structures and investment approaches. This article clarifies the distinctions between REITs and ETFs, explaining each individually and their relationship within the investment landscape.

What is a REIT?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate across various property types. These entities allow individual investors to earn dividends from real estate investments without buying, managing, or financing properties directly. REITs offer a liquid way to invest in real estate, as their shares trade on major stock exchanges.

To qualify as a REIT, a company must meet specific requirements set forth by the Internal Revenue Service (IRS). REITs must distribute at least 90% of its taxable income to shareholders annually as dividends. This distribution requirement distinguishes REITs and provides investors with a steady income stream. These dividends are paid out from the rental income generated by their properties or interest earned from their real estate financing activities.

REITs can be broadly categorized into several types based on their investment focus. Equity REITs own and operate income-producing real estate, earning revenue primarily from rents. Mortgage REITs (mREITs) provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities, earning from net interest margin. Hybrid REITs combine strategies of both equity and mortgage REITs.

What is an ETF?

An Exchange Traded Fund (ETF) is an investment fund holding a collection of assets like stocks, bonds, or commodities. ETFs trade on stock exchanges throughout the day, like individual stocks, offering flexible buying and selling. Their market price can fluctuate based on supply and demand, but it stays close to the fund’s net asset value (NAV).

ETFs are designed to track a specific index, sector, or commodity, offering investors diversification through a single investment. For instance, an ETF might track a broad market index like the S&P 500, a specific industry, or a commodity’s price. This allows exposure to a wide range of assets without purchasing each component.

ETFs involve authorized participants, institutional investors who create and redeem large blocks of shares. This process ensures the ETF’s market price aligns closely with its underlying assets’ value. When the market price deviates from its NAV, authorized participants create or redeem shares, correcting the imbalance. This structure contributes to the efficiency and liquidity of ETFs.

The Relationship Between REITs and ETFs

While REITs and ETFs are both investment vehicles, they are different in their nature and purpose. A REIT is a company specializing in real estate, providing a way for individuals to invest in income-producing properties. Conversely, an ETF is an investment fund holding a diverse portfolio of assets, which may or may not include real estate.

ETFs often include REITs, especially those designed for real estate sector exposure. For example, a “REIT ETF” invests in multiple REIT stocks. This provides diversified real estate market exposure through a single purchase, rather than selecting individual REITs.

A REIT itself is never an ETF. Instead, a REIT is a company whose shares can be bought individually or included as holdings within an ETF. This is similar to how a technology ETF holds numerous technology company stocks; the individual company is not an ETF, but its stock can be part of one. Thus, an ETF can contain REITs, but a REIT is a corporate structure.

Key Distinctions for Investors

Understanding the differences between directly investing in individual REITs and through REIT-focused ETFs is important. Diversification is a key distinction. Individual REITs offer exposure to a single company and its property portfolio, while REIT ETFs provide built-in diversification across multiple REITs, property types, and geographical locations. This broader exposure within an ETF mitigates risks associated with the performance of any single REIT.

Management and fees are another notable difference. ETFs have lower expense ratios compared to actively managed mutual funds, making them cost-effective for sector exposure. However, when investing directly in individual REITs, investors avoid fund management fees entirely, though standard brokerage commissions apply. The choice between these two options depends on an investor’s preference for direct control versus professional management and cost efficiency.

Both individual REITs and REIT ETFs trade on stock exchanges, providing liquidity. An individual REIT represents shares of a single company; an ETF represents a basket of securities. This means investors have direct control over selecting specific REITs, allowing targeted exposure to specific real estate segments. Conversely, an ETF’s holdings are determined by its underlying index or the fund manager’s strategy, offering less direct control over individual selections.

Regarding tax implications, dividends from REITs, whether held directly or through an ETF, are taxed as ordinary income for non-corporate shareholders. This differs from qualified dividends from many other corporations, which may be taxed at lower capital gains rates. Investors should be aware that REIT income is subject to their ordinary income tax bracket.