Key Takeaways

  • With regard to private commercial real estate investment opportunities, there are two common options: private REITs and private equity real estate firms.
  • A private REIT is a tax advantaged entity who offers securities to accredited investors through direct marketing, financial advisors, and broker-dealer networks.  Investor funds go into “pools” of capital that are allocated as the investment manager sees fit.
  • A Private Equity Real Estate Firm has a similar mandate – to deploy investor capital into real estate assets – but operates under different legal, tax, and dividend structures.
  • One option isn’t necessarily better than another.  Rather, the details of their structure should be considered carefully to see which aligns with an investor’s needs and preferences.

Individuals looking to add private commercial real estate investments to their portfolio typically have two choices, Private Equity Real Estate Firms or Private Real Estate Investment Trusts (REITs).  While their names sound somewhat similar and their business is generally the same, there are material differences between the two that can affect investment returns.  These differences are the subject of this article.

Real Estate Investment Trusts (REITs) – Defined

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. They are formed as corporate entities so investors are able to purchase shares in them.  Doing so provides access to the income and profits produced by the underlying real estate assets.  

One of the unique features of a REIT is that it is a tax advantaged structure as long as they meet the following IRS requirements:   

  • Invest at least 75% of total assets in real estate and derive at least 75% of gross income from rents on real property, interest on mortgages financing real property, or from sales of real estate
  • Pay at least 90% of taxable income in the form of shareholder dividends annually
  • Be an entity that is taxable as a corporation that is managed by a board of directors or trustees
  • Have a minimum of 100 shareholders with no more than 50% of shares held by five or fewer individuals

REITs can invest in a variety asset classes (like multifamily, office buildings, or industrial assets) and they can be publicly or privately traded.  Shares in publicly traded REITS can be bought and sold on public exchanges like the New York Stock Exchange (NYSE).  Or, if it is a private non-traded REIT, their shares are bought and sold in private transactions that are facilitated by broker-dealers or through the REITs themselves.  

Private REIT shares are sold to individual and institutional investors through an exemption in Securities and Exchange Commission (SEC) registration requirements that mandates all purchasers be accredited investors.  This means that buyers of their shares must meet certain income, net worth, and/or sophistication requirements.

Private Equity Real Estate Firms – Defined

Private Equity Real Estate firms have a similar mandate to REITs, to pool investor money and deploy it in real estate assets. Like REITs, the securities offered by Private Equity Real Estate firms are also privately traded and only available to accredited / high net worth investors. 

There are several key differences between a private equity firm and a REIT.  They include:

  • Tax Structure:  Private equity firms are not required to pay out a high percentage of their income to maintain a tax advantaged status.  Their distributions are tied to the income and profits produced by their underlying properties.  In addition, private equity investors benefit from other tax benefits like  depreciation and the opportunity for tax deferrals upon sale.
  • Fees:  The fee structure between a private equity firm and REIT can vary significantly.  Private equity firms charge small fees for things like asset management and administrative tasks, but derive the bulk of their income from splitting the property’s cash flows with investors.  REITs are commonly sold through financial advisors and brokerages so they can have high upfront fees (up to 15%) that are used to pay for marketing and sales commission expenses.  
  • Funds vs. Deals:  REITs are similar to mutual funds in the sense that investor dollars go into real estate funds whose cash is deployed into real estate properties.  As such, investors often don’t have direct knowledge of the properties that they are invested in.  On the other hand, private equity real estate investments often allow investors to fund a specific deal.  This way, they know exactly where the property is located, who the tenants are, and how much they pay in rent. 
  • Dividends:  As mentioned earlier, REITs are required to pay out a high percentage of their earnings in the form of dividends.  In order to show a high yield, these dividends can sometimes be paid from investor capital or debt, not from property income.  This can raise the risk profile of the investment.  Should investor capital or debt dry up, the REIT may be unable to pay the advertised dividends.   

Which is Better?

The benefits of investing in private REITs or private equity real estate deals are generally the same: portfolio diversification, lower price volatility, and high total returns.  The truth is, one isn’t necessarily “better” than the other.  Rather, they should be chosen based on each individual investor’s preferences, investment strategy,  liquidity needs, and risk tolerance.

Given that these preferences can vary widely from one person to another, it is important that each individual perform a significant amount of due diligence on their transaction sponsor, the investment opportunity, their fees, the required holding period, liquidity availability, and legal structure prior to committing funds to an investment.

Interested in Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

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