Mortgage Funds vs. REITs: Understanding the Differences

When it comes to real estate investing, there are two popular options that you might have heard of: mortgage funds and Real Estate Investment Trusts (REITs).  Both of them would offer you opportunities to gain exposure to the real estate sector, but they work in fundamentally different ways.  Understanding these differences is the key to making an informed investment decision.

What Are Mortgage Funds?

Mortgage funds are investment vehicles that pool money from investors to lend to borrowers for real estate-related purposes.  These funds would primarily focus on providing you with financing for real estate transactions, such as home loans or commercial real estate developments.  If you’re an investor in mortgage funds, you basically earn returns from the interest payments made on the loans.  Mortgage funds can be direct or indirect, with some investing in loans directly while others may fund mortgage-backed securities (MBS).

Typically, these funds would focus on lending to borrowers in a specific market or sector like residential or commercial properties.  For example, 268 Fund mortgage funds are known for targeting both residential and commercial real estate loans as they provide returns based on the interest generated from the properties they finance.

What Are REITs?

Real Estate Investment Trusts (REITs) are companies that would own, operate, or finance income-producing real estate.  REITs would allow you to buy shares in large-scale, income-producing real estate portfolios.  These can include office buildings, retail spaces, residential complexes, hotels, or even industrial warehouses.  REITs primarily generate income through rent paid by tenants of their properties.  But they are basically required by the law to distribute at least 90% of their taxable income as dividends to shareholders so it’s pretty much good as a consistent income.  Unlike mortgage funds, which focus on real estate loans, REITs own and manage physical properties or invest in real estate assets like mortgage-backed securities.

Key Differences Between Mortgage Funds and REITs

1. Investment Focus: The most significant difference between mortgage funds and REITs lies in the types of assets you invest in.  Mortgage funds focus on real estate loans, while REITs focus on owning or managing physical properties.  Mortgage funds also provide you with funding to borrowers and earn interest, whereas REITs would generate income for you primarily from rental income or property sales.
2. Risk and Return Profiles: Mortgage funds tend to have a more direct connection to the real estate market, particularly through the lending process.  But the risk here is largely tied to the ability of borrowers to repay their loans.  On the other hand, REITs are subject to market conditions, including property values and tenant demand.  That is because REITs often own properties that require ongoing management and maintenance so you face a much higher operational risks.
3. Liquidity: REITs generally offer more liquidity than mortgage funds because they are traded on public exchanges, which allows you to buy and sell shares easily.  Mortgage funds, however, may have limited liquidity, especially in the case of private funds, where you may be required to lock in your capital for a longer period.
4. Diversification: REITs typically offer greater diversification than mortgage funds.  A REIT’s portfolio may consist of different types of properties in different geographic regions, whereas mortgage funds often focus on specific types of loans or markets.
5. Warehouse: In the mortgage funds space, some funds may use a warehouse facility, which is a line of credit that enables them to finance multiple loans simultaneously.  This also allows mortgage funds to manage liquidity and scale their lending activities more efficiently.  Warehouse facilities can be crucial for mortgage funds looking to expand their loan portfolios and offer competitive returns to their investors.

Conclusion

Overall, both mortgage funds and REITs can provide you with valuable ways to invest in real estate.  Mortgage funds focus on lending and earning returns through interest, whereas REITs offer ownership in real estate properties, with income generated primarily from rents.  So whichever you may choose, don’t forget to research properly and take your time before choosing which to invest in.