When investing in real world real estate, many choose REITs or funds rather than buying and maintaining entire properties. REITs and funds allow investors to diversify their investments. They also allow investors to spend less money on a single property – whether a shopping mall, business complex, data center or apartment building. While investors spend less, they still make money off those who rent and use those spaces. Furthermore, investing in REITs and funds is fairly hands-off as investors need not maintain these facilities. In some cases, investors might not even choose the securities or stocks they invest in. Of course, many REITs and funds have minimum investment requirements. However, these minimum investment amounts typically range between $1,000 and $25,000 – far less than one would spend to buy an entire hospital, housing complex or commercial office building. By diversifying across REIT and fund types – e.g. healthcare, industrial, infrastructure, retail, etc. – investors can also hedge their bets. A diversified portfolio of fractionalized investments is often better protected against swings in the market or changes in consumer preferences. For example, those who invested in a variety of equity REITs before the pandemic hit likely lost less than those who purchased an entire office building or invested solely in office REITs. In short, the risk investors take when buying into REITs and funds is much lower than that of buying a property outright – especially in uncertain times. In the Metaverse – where the future of virtual real estate is still highly speculative – REITs and funds allow investors to get involved without incurring significant risk. Follow below to learn everything you need to know about investing in Metaverse REITs and funds in 2022. See our companion piece — a glossary of “terms to know” — for background on blockchain, Web3, NFTs and more if you are unfamiliar with the metaverse and its origins.
REITs and Funds as Part of Your Metaverse Real Estate Portfolio
In the real world, both real estate funds and real estate investment trusts allow traditional real estate investors to diversify their portfolios without purchasing entire properties. Late last year, several companies established virtual real estate investment trusts and virtual real estate funds in the virtual real estate world. Even in such early stages of the metaverse, leading real estate developers have already expressed interest in metaverse real estate projects like concert venues, commercial office buildings and luxury shopping malls.
In some ways, market watchers and industry experts believe the metaverse real estate industry will mirror the traditional real estate industry. Real estate veterans in commercial and residential sectors will buy up land and develop it. Businesses will then rent retail space and remote workers will rent co-working spaces from these developers. Families will invest in residential real estate, buying single family homes for their avatars to “live” in. As long as the metaverse truly becomes an extension of our real world lives, users will attend virtual concerts, meet up for virtual coffee and shop for virtual clothes to dress their avatars.
In other words, they will spend massive amounts of real world money on virtual assets and experiences. If users continue to invest in these digital worlds, virtual REITs and funds could help achieve a primary goal for the metaverse and Web3 in general: democratization. Plots of land in the metaverse have recently sold for millions, with Republic Realm spending $4.3 million on a single parcel of virtual land in Sandbox. Sandbox is a leading metaverse real estate platform supported by Ethereum.
However, fractional metaverse real estate allows users to invest in a new and emerging world without incurring the kind of risk that comes with buying entire plots of land. As we explain in our post “Fractional Ownership Helps Millennials Enter Real Estate Market,” fractionalized investment makes owning metaverse real estate possible for those who cannot afford to buy an entire property. Below, we consider how REITs and real estate funds like Realm, Alchemy and MetaSpace Real Estate Investment Trust might perform if/when the metaverse continues to pull in new users.
REITs vs. Real Estate Funds
REITs and real estate funds are both real estate investments. According to Erin Gobler in her article “Real Estate Funds vs. REITs: What’s the Difference?” for The Balance, “real estate funds and REITs make real estate investing more accessible since they eliminate the large upfront cost that would be required to purchase real estate on your own.” While similar in some ways, there are a few key differences between the two. These differences relate to trading, taxation, risk level and investment terms. In short, REITs and real estate funds have different advantages and disadvantages for investors. We define REITs and funds below, detailing the pros and cons of each.
Real Estate Investment Trusts (REITs)
First, real estate investment trusts or REITs are real estate companies that buy up income-generating properties and debt across a variety of industries. These industries include healthcare, retail, agriculture and even residential mortgages. About a quarter of all real world REITs are in retail while only 10% are mortgage REITs.
Though some are private, most of these companies are publicly traded on stock exchanges unlike other real estate asset classes. This allows for both diversification and liquidity, the latter of which is relatively rare when investing in real estate. The fact that REITs are traditionally traded on stock exchanges makes establishing REITs in the metaverse a bit confusing this early on in its development. More on how a real estate investment trust might function in the metaverse later.
In his article “5 Types of REITs and How to Invest in Them” for Investopedia, Will Ashworth writes that these investments are popular because they offer “greater diversification, potentially higher total returns, and/or lower overall risk.” Investors often consider REITs – particularly diversified REITS – to be reliable, low-risk investments that “provide high dividend yields along with moderate long-term capital appreciation.” According to Ashworth, “real estate investment trusts are historically one of the best-performing asset classes available.” Ashworth notes that the FTSE NAREIT Equity REIT Index’s “average annual return was 9.5%” between 2010 and 2020.
Pros and Cons of Investing in REITs
Writing for SmartAsset, Stephanie Colestock explains that there are three different types of REITs. These include mREITs – also called mortgage REITs –, equity REITs and hybrid or diversified REITs. Most mortgage REITs, equity REITs and hybrid REITs are traded on stock exchanges, making it easy for investors to buy and sell these assets. Of all the many benefits of investing in REITs, liquidity might be the most attractive.
While mortgage REITs “typically offer higher dividends than other REIT types,” they make up only a small share. mREITs “play an integral role in US mortgage markets” and do not require investors to manage any assets. One potential disadvantage to investing in mREITs is that they can be affected by changes in the housing market, including interest rate fluctuations.
While mREITs let investors earn on debt, equity REITs focus “on building, developing, managing, repairing and sometimes selling investment property.” From office buildings and shopping malls to housing developments and resorts, equity REITs “allow individuals to invest in properties and projects that they might not otherwise be able to afford.” According to Colestock, benefits of investing in eREITs include dividends that “provide investors with passive income” and historically higher yields than the S&P 500 average.
Of course, eREITs can be impacted by changes in consumer preferences, “industry cycles and market rate changes.” For example, retail and office space eREITs were hit during the COVID-19 pandemic when many Americans transitioned to remote work. eREITs also have higher minimum investment requirements and might charge other fees.
Diversified or Hybrid REITs
Hybrid or diversified REITs combine “both mortgage and equity investments” within a single trust. Diversifying investments through hybrid REITs can limit loss, as housing market changes and industry cycles will only affect certain assets. Hybrid REITs allow investors to “generate income from both tenant rental payments and loan interest.” However, this reduced volatility usually “equates to lower returns” – i.e. low risk, low reward.
REIT Income Taxation
Returns from mREITs, eREITs and diversified REITs were historically taxed like regular income with very few exceptions. In 2018, these rules changed somewhat. Ellen Chang explains In her article “7 Differences Between Real Estate Funds and REITs” for US News. Chang writes that “income distributions from REITs held in mutual funds are now eligible for a new 20% pass-through deduction called Qualified Business Income (QBI).” Once taxed “at the top tax rate of 37%,” income distributions from certain REITs now “top out at 29.6%.”
Real Estate Investment Funds
Next, we have real estate investment funds. Writing for The Motley Fool, Matthew DiLallo explains what real estate investment funds offer investors. DiLallo writes that a real estate fund “is an entity formed to pool investor money and collectively purchase securities such as stocks, bonds, or real estate.” In short, a real estate fund is “a combined source of capital used to make real estate investments.”
Aside from ETFs, most real estate investment funds have low initial investment thresholds. They allow investors to accumulate passive income without any involvement, as most funds are managed by an advisor. Like REITs, real estate investment funds allow investors to diversify their real estate assets.
Types of Real Estate Investment Funds
There are three different types of real estate investment funds: exchange-traded funds, mutual funds and private equity funds. According to DiLallo, mutual funds “are professionally-managed investment vehicles [that] invest money pooled from investors into a diversified portfolio of real estate opportunities.” These opportunities include “direct ownership of real estate” as well as REITs and other real-estate related companies. Your financial advisor can purchase mutual funds for your portfolio as long as your investment amount meets or exceeds the fund’s minimum requirement.
Like REITs, ETFs or real estate exchange-traded funds are traded publicly on stock exchanges. They are “passively-managed investment vehicles [that] track an underlying index.” This allows ETFs to deliver investors “market-matching returns.” Lastly, we have private equity funds, which don’t really cater to amateur investors. Instead, private equity funds “target institutional investors and high-net-worth-clients.”
Key Differences Between Real Estate Funds and REITs
#1 REITs Offer Investors More Control Than Real Estate Funds
First, REITs allow investors to choose which assets they invest in. Real estate funds are “actively managed,” meaning individual investors rarely choose which properties they invest in. Erin Gobler explains in her article “Real Estate Funds vs. REITs: What’s the Difference?” for The Balance. Gobler writes that a fund “takes money from its many investors and uses it to invest in a variety of securities.” Managers of the fund might choose to sell certain securities without input from individual investors.
A REIT, however, is one real estate investment company that buys and manages different properties. Gobler writes that “investors can buy stock in the REIT, therefore becoming part owner of the company and its holdings.” When you invest in a fund, you are investing in dozens of companies but when you invest in a REIT, you are investing in just one. According to Gobler, some investors “prefer REITs over real estate funds…[because] investing directly in an REIT allows you to be selective of the company and the type of real estate you want to invest in.”
#2 REITs Are Subject to Stricter Standards than Funds
The IRS regulates REITs more intensely than real estate investment funds. In many cases, these higher standards actually make REITs more attractive than funds to investors. Writing for NerdWallet in his article “Best-Performing REITS: How to Invest in Real Estate Investment Trusts,” Kevin Voigt explains.
Voigt writes that each real estate investment trust is required by the IRS to “return a minimum of 90% of taxable income in the form of shareholder dividends each year.” They are also required to “invest at least 75% of total assets in real estate or cash [and] receive at least 75% of gross income from real estate.” Lastly, these companies must each have “a minimum of 100 shareholders after the first year of existence [and] ave no more than 50% of shares held by five or fewer individuals during the last half of the taxable year.” Funds are not subject to any of the standards listed above.
#3 REITs Behave Like Stocks While Real Estate Investment Funds Behave Like Mutual Funds
How REITs and funds behave is another key difference between the two. As Ellen Chang explains in her article “7 Differences Between Real Estate Funds and REITs” for US News, “REITs are traded like an exchange-traded fund or stock, while a real estate fund is a mutual fund that invests in securities offered by public real estate companies.” Unlike mREITs and eREITs, funds offer investors “diversification across multiple property sectors and geographies.”
#4 REITs and Real Estate Investment Funds Are Taxed Differently
As of 2018, income distributions from real estate investment trust are now taxed at a lower rate because they are eligible for a 20% pass-through deduction. In our post “Tax Deductions and Credits for First-Time Homeowners You Need to Know About,” we explained that the pass-through deduction lowers the marginal tax rate of qualifying income from rental properties and other investments. This now applies to income from REITs as well. Income from real estate investment funds is not taxed in the same manner. If your fund sells securities you have invested in, you could owe capital gains tax in addition to the taxes you pay on dividends.
REITs and Funds on Metaverse Platforms
As of March 2022, there are a few different REITs and real estate investment funds in the metaverse. Metaverse Property – which operates across several virtual worlds – was the very first company to get involved in this space. According to Stephanie Hughes in her article “People are paying real money for virtual real estate in the metaverse” for The Financial Post, Metaverse Property created “the first ‘metaverse real estate investment trust.’” Investors will trade metaverse REITs “through a non-fungible token (NFT) that is backed by the company’s virtual land portfolio.” In December 2021, MetaSpace Real Estate Investment Trust (MREIT) was already trading on PancakeSwap – a DEX or decentralized exchange where investors can trade tokens.
Kristi Waterworth reports on this development in her article “Are Fractional Metaverse Real Estate Shares a Smart Investment?” for NASDAQ. In just a few months, MREIT has already seen “explosive growth,” leading Waterworth and others to believe “more virtual real estate funds will follow.” However, investors should keep in mind that these projects are not technically REITs. Waterworth notes that projects like MREIT exist “within the cryptocurrency/NFT space and [are] not traded on any stock exchange.”
Those interested in metaverse real estate investment might also consider virtual funds. For example, the crowdfunding platform Republic just announced a new investment fund for metaverse property. In an article for MillionAcres, Jeff Piltch writes that Republic’s private equity fund Realm “plans to purchase parcels of land across several online worlds and develop them into virtual stores, hotels, and more.” At this point in time, Republic’s fund “is invite-only [with] a minimum investment of $25,000, and is limited to accredited investors.” In addition to Republic, Alchemy recently launched its own venture capital fund. Sfermion is another virtual real estate investment fund gaining traction in the metaverse.
Are Metaverse REITs and Real Estate Investment Funds Profitable?
The performance of these trusts and funds depends largely on the future value of virtual real estate. Since last summer, parcels of land in several virtual worlds have shot up in value. According to Andrea Day and Chris DiLella in their article “Investors are paying millions for virtual land in the metaverse” for CNBC, prices of digital real estate in Decentraland “‘have gone up 400% to 500% in the last few months.’”
Real estate sales in Sandbox – another metaverse platform – have also set records. Day and DiLella write that Republic Realm sold a hundred virtual private islands in Sandbox for $15k each last year. In January 2022, those virtual private islands were each selling for “about $300k each.“ Whether this is sustainable or a metaverse real estate bubble remains to be seen. Regardless, the viability and profitability of virtual REITs and real estate investment funds is intrinsically linked to continued user engagement and investor confidence. For now, value of land in the metaverse is highly speculative.
Does It Make Sense to Invest?
Quoting Janine Yorio of Republic Realm in an article for CNBC, Chris DiLella and Andrea Day write that spending money on digital real estate of any kind – whether that means buying a plot of land or investing in a fund or REIT – “‘is highly, highly risky.’” Yorio advises prospective investors to “‘only invest capital that you’re prepared to lose…[because digital real estate] is blockchain-based [and] crypto is highly volatile.’” Of course, your investment could certainly turn a profit – but only if you choose the right fund or property while interest in the metaverse grows.
Digital real estate is somewhat insulated from real world threats. However, the old adage “location location location” will still ring true in metaverse real estate. Without foot traffic, the retail stores, commercial offices or concert venues owned by you, your REIT or your real estate investment fund will not appreciate or deliver returns. Still, you might consider the potential reward well-worth the risk. Cautious metaverse investors might consider REITs or funds instead of buying plots of virtual land – especially as these lots sell for millions of US dollars.