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REITs vs ETFs: Definitions, Key Differences, Pros & Cons

After signing the dotted line, new homeowners may be searching for a way to regain some of their home buying costs. And one way is to invest in a REIT or an ETF. Learn the pros and cons of both investments and which one may give you higher returns.
After signing the dotted line, new homeowners may be searching for a way to regain some of their home buying costs. And one way is to invest in a REIT or an ETF. Learn the pros and cons of both investments and which one may give you higher returns.

Whenever you make a big purchase, like buying a new home, you may feel a bit cash-strapped after the initial home purchase, new mortgage, property taxes, and homeowner’s insurance — to name a few pricey expenditures.

And for many new homeowners who are looking for a way to recoup some of their spending, one approach is to invest in a REIT (real estate investment trust) or ETF(exchange traded fund), which can be a smart investment in your long-term financial plan.

Both REITs and ETFs can help you create a passive income and bring in extra gains benefiting your financial situation or even your retirement down the line.

But before you start handing over any extra savings, you’ll want to know the advantages and disadvantages of each investment in order to decide which one makes the most sense for you.

REIT—Real Estate Investment Trust

A REIT is a company that owns and manages several income-producing real estate properties. The success of the REIT is based on collecting rent or leasing out property, and then passing on a portion of that gain to their shareholders — i.e. you.

REITs are an attractive option for many investors because of their steady, high dividends as well as their liquidity. Your money won’t be tied up. Much like stocks, you can buy and sell REIT shares quickly.

REITs make their money through rent and property appreciation, typically specializing on only one aspect of the commercial real estate market such as office buildings, storage space, apartment buildings, medical facilities, or hotels.

With this narrow focus on specific sectors of the real estate market, REIT investments don’t usually provide much diversification for your portfolio and are subject to fluctuations based on market conditions.

The advantage, however, with a REIT’s method of gaining income is that you’ll see continuous dividend earnings simply by holding a REIT, and won’t have to worry about buying or selling at the right moment in order to see a profit.

REITs are required to pay 90% of their income back to shareholders through dividends. And while this is great for you, as you’ll see larger dividends, this also means there isn’t much capital appreciation — the REIT can only reinvest 10% of their profits.

Also be aware, REIT dividends are taxed as normal income meaning you’ll be taxed a higher rate than if you received dividends through a stock.

But with liquidity and stable, high dividends, REITs can be an enticing option for investors.

ETF—Exchange Traded Fund

Unlike REITs, ETFs don’t necessarily focus on one particular market. Indeed, ETFs have built-in diversification as they are a collection of hundreds or thousands of different stocks and bonds all in one fund.

For instance, an ETF could be incredibly diverse and contain all the stocks followed by the S&P 500 index or the ETF could focus on one industry like banking, and include all the banks in the market.

You’ll find several other types of ETFs such as Bond ETFs which can include government bonds, corporate bonds, and municipal bonds, Commodity ETFs which focuses on oil or gold, as well as Currency ETFs that invest in foreign currencies.

ETFs are traded on the stock exchange exactly like stocks. And while you may not see the same steady, high dividends as with a REIT, with an ETF, you’ll find a more consistent and lower-risk investment.

For example, if one company or stock within your ETF isn’t doing well, it’s likely another stock or bond within that same ETF is performing well. An ETF’s widespread diversity creates balance and can help minimize any loss.

And to see more profit and help minimize your risk even further, it’s recommended to choose stable and established companies to make up your ETF as well as pick companies that also pay out dividends at least quarterly.

One disadvantage, is that unlike REITs, ETFs have noone actively managing or trying to add value to your investment. An ETF is a passive investment where, for better or worse, you’re at the mercy of the performance of the stocks, bonds, and companies that make up your ETF.

Choosing a REIT or ETF

Both a REIT and ETF have benefits that can help you earn money down the road. Which you choose simply depends on your current needs and future goals.

If you’re looking for an immediate steady flow of income, a REIT with its high dividends might be the best route, though if you’re looking for long-term stability and lower risk, an ETF could be the better decision.

You can also go with a REIT ETF combo — REIT and ETF investments are not mutually exclusive. For instance, you can get the best of both by investing in an ETF that exclusively invests and works with REITs.

And before you make any financial decision, it’s best to talk with a professional advisor who can guide you through all your options and help you decide what is best for your future.

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Ben Mizes

Ben Mizes is the co-founder and CEO of Clever Real Estate, the free online service that connects you with top agents to save thousands on commission. He's an active real estate investor with 22 units in St. Louis and a licensed agent in Missouri. Ben enjoys writing about real estate, investing, personal finance, and financial freedom. He's a serial entrepreneur, having run several successful startups before Clever Real Estate. Ben's writing has been featured in Yahoo Finance, Realtor News, CNBC, and BiggerPockets.

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