Mortgage REIT vs. Equity REIT: Key Differences and Financial Insights

Real estate investment trusts (REITs) allow investors to access real estate without directly owning properties. They fall into two main categories: mortgage REITs (mREITs) and equity REITs, each with distinct business models and risk profiles that shape financial performance. Understanding these differences helps investors align their choices with their risk tolerance and financial goals.

Portfolio Composition

Mortgage REITs invest in real estate debt instruments, including residential and commercial mortgage-backed securities (MBS), whole loans, and other mortgage-related assets. Their returns come from interest income, with portfolio composition influenced by credit quality, loan duration, and prepayment risk. Some mREITs focus on agency-backed securities, which are guaranteed by government-sponsored enterprises like Fannie Mae and Freddie Mac, offering lower risk but also lower yields. Others invest in non-agency loans, which carry higher credit risk but provide greater income potential.

Equity REITs own and manage income-producing properties across sectors such as residential, office, retail, industrial, and healthcare. Their revenue comes from rental income and property appreciation. A retail REIT may own shopping malls and strip centers, while an industrial REIT might specialize in warehouses and distribution centers. Some equity REITs diversify across multiple property types to reduce risk and enhance stability.

Financing and Interest Rate Exposure

Mortgage REITs rely heavily on short-term borrowing, often using repurchase agreements (repos) and other forms of leverage to acquire mortgage assets. Their profitability depends on the spread between the yield on mortgage holdings and borrowing costs, making them highly sensitive to Federal Reserve policy and interest rate fluctuations. Rising short-term rates can compress net interest margins, while an inverted yield curve—where short-term rates exceed long-term rates—can erode profitability.

Equity REITs finance their properties through a mix of equity offerings, long-term debt, and retained earnings. They issue corporate bonds, take out commercial mortgages, or use credit facilities to fund acquisitions and developments. Many use fixed-rate debt with long maturities, reducing immediate exposure to short-term rate changes. However, rising interest rates can still increase refinancing costs and affect property valuations, potentially impacting their ability to raise capital.

Income and Dividend Characteristics

Mortgage REITs typically offer higher dividend yields because their earnings come from interest income. However, these payouts can be volatile, fluctuating with borrowing costs, prepayment rates, and credit market conditions. Since mREITs distribute most of their earnings as dividends, they retain little capital for reinvestment, making them more vulnerable to economic shifts.

Equity REITs generate income through rental payments, providing a more stable revenue stream. Many follow a dividend growth strategy, increasing payouts annually as leases are renewed at higher rates or as new properties are added. This consistency appeals to long-term investors seeking steady income, while mortgage REITs attract those willing to accept higher risk for potentially greater yields.

Regulatory and Tax Dimensions

To maintain their tax-advantaged status, REITs must distribute at least 90% of their taxable income to shareholders annually. They must also derive at least 75% of their gross income from real estate-related sources, such as rents or mortgage interest, and hold at least 75% of their total assets in real estate, cash, or government securities. Failure to meet these requirements results in taxation as a regular C corporation, reducing profitability.

Tax treatment varies by REIT type. Equity REIT dividends are generally classified as ordinary income, though some portions may qualify for the 20% pass-through deduction under the Tax Cuts and Jobs Act (TCJA) until at least 2025. Capital gains from property sales are taxed at long-term capital gains rates, currently capped at 20% for most investors. Mortgage REIT dividends, derived from interest income, are typically taxed as ordinary income at rates up to 37%.