Compounding Debt: The Dark Side of Compounding Interest
Compounding interest can be a powerful tool to have in your arsenal. It can be very beneficial and create large sums of money over time if wielded correctly. But unfortunately,…
November 13, 2019
If you’re considering getting involved in a REIT (Real Estate Investment Trust), you should know that there are two different types: equity REITs and debt REITs. Both can be valuable for investing, depending on your financial situation and goals.
Here’s what to consider when you’re trying to choose between these two options and decide if either is right for you:
It’s a good idea for investors to have diverse income sources. That can help protect them from serious financial harm if one of their investments goes bad, or if an income source becomes less lucrative over time. No matter the size of the nest egg an investor has built, there’s always room for continued investing to add to their financial security.
Standard investors of any age, as well as retirees, would do well to choose a REIT as part of their portfolio. This can provide diversification and the potential for high yields, as well as the luxury of being a passive investment. Investing in a REIT can be very beneficial, but choosing the right kind is a critical part of getting the most value from your investment decision.
In an equity REIT, properties are acquired throughout the commercial real estate spectrum. These properties are selected and purchased by the REIT. These can be properties such as:
Businesses lease space and tenants rent apartments, allowing the REIT to collect revenue. In time, the value of the real estate owned by the REIT may also rise due to appreciation. That will lead to a stronger investment for the people who have invested in that REIT and can bring them more security.
If a company raises funds from investors and uses those funds to purchase a commercial property, then leases out space in that property until all those leased spaces are full, that company would be considered an equity REIT. By purchasing the property, the REIT holds equity in that location, in the same way that a homeowner would hold equity in their home when they paid their mortgage down or paid it off, or when they paid cash to buy their house.
Some equity REITs specialize in certain types of properties, while others are more general and will purchase various properties in the commercial space. When an equity REIT specializes in a property type, the most common types are apartment buildings, office buildings, shopping centers, and self-storage facilities. The REIT will have operating costs associated with the properties, along with offering and organizational costs. After that, 90 percent of the REIT’s income must be paid to its shareholders.
A debt REIT, which is also commonly known as a mortgage REIT, provides properties for investment in a different way. This type of REIT lends money to buyers of real estate in exchange for a debt instrument. These instruments can be mortgages, preferred equity structures, mezzanine loans, and other options. The revenue the REIT generates comes from the interest on the debt instruments. In the same way as equity REITs, debt REITs have to pay at least 90 percent of their revenue to their shareholders. But these REITs do not see any benefit from the appreciation of the properties on which they have loaned money.
If a company qualifies as a REIT, makes a loan to someone who purchases commercial property, and collects interest on that loan, that company is a debt REIT. These REITs do not own any property, but invest in mortgages, instead. By loaning money to others in the form of mortgages and related types of debt instruments, and by purchasing mortgages that already exist, the company generates revenue through the interest earned on those debts. While this can be a strong source of revenue, it is important to be clear that these REITs do not actually own any physical real estate at all.
There are similarities and differences between equity REITs and debt REITs. This can make choosing one or the other confusing to an investor without commercial real estate experience. To help decide which REIT type is right for your investment goals, consider the following points:
Understanding what REITs have to offer and what potential pitfalls can appear is very important. Thorough knowledge of these commercial real estate investment vehicles gives investors the opportunity to decide if an equity REIT or debt REIT would be right for them.
When you choose an equity REIT like DiversyFund, you know that you will be investing in owned property, not in the mortgages of other people. DiversyFund focuses on apartment buildings and offers a public, non-traded REIT that can be studied, monitored, and understood, in order to make the best investment decision. You can get your questions answered by us at DiversyFund before you invest, giving you the knowledge and security to make an informed decision about where to put your money. Learn more about the DF Growth REIT today and let us help you diversify your portfolio through real estate.