REITs vs. Real Estate Mutual Funds vs Private Equity – Which is the Best For Investment?


Key Takeaways

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Institutional grade commercial real estate assets are very expensive.  In most cases, their outright purchase is not realistic for most individual investors.  But, this doesn’t mean that they can’t invest in them.

Fortunately, financial markets have created a number of vehicles through which individual investors can gain exposure to the commercial real estate asset class, either through fractional ownership or investments in companies that own commercial real estate.

In this article, the pros and cons of three such options are discussed:  REITs, Real Estate Mutual Funds, and Private Equity.

What is a REIT?

The term “REIT” is an acronym for Real Estate Investment Trust.  These are specialized companies formed specifically for the purpose of financing, owning, and/or operating real estate assets.  REITs invest in all types of commercial real estate assets from multifamily to industrial and office.

Individuals seeking exposure to a particular asset class or property type can purchase shares in a REIT, which entitles them to a share of the income produced by the underlying assets.  A REIT can be publicly traded, meaning its shares can be bought and sold on public exchanges (e.g. Camden Property Trust is a large  multifamily REIT).  Or, they can be private, which means that shares are not sold on public exchanges and are only available to certain high net worth investors (accredited investors).

From an individual’s standpoint, the benefits of investing in a REIT include:

  • Steady income with the potential for participation in capital gains upon sale
  • Diversification 
  • Favorable tax treatment 
  • Strong returns 
  • Generally low price correlation with stocks and bonds 
  • Liquidity because shares can be bought and sold (publicly traded REITs only)

While these benefits are impressive, there are also a number of drawbacks investors should be aware of.  To start, individual investors have no say in which real estate properties are bought and sold with their investment capital.  In addition, they have no say in day to day asset management decisions or when/if the property is sold.  Finally, private REITs in particular can have high fees – which can impact investment performance – and may require investors to commit capital for a significant period of time (5+ years).  For these reasons, investors may prefer an alternative investment strategy.

What is a Real Estate Mutual Fund?

A real estate mutual fund is similar to a REIT in the sense that they are a vehicle through which investor capital is pooled and deployed into commercial real estate assets. However, their legal structure is completely different, they are not required to meet the same IRS rules regarding dividend distribution, and the assets consist of the publicly traded shares of other companies that own commercial real estate (including REITs).  Real estate mutual funds are administered by large investment companies and investors can purchase shares in them directly.  For example, the Vanguard Real Estate Index Fund is a large real estate mutual fund that invests in the shares of other publicly traded REITs.

The benefits of a real estate mutual fund are similar to those of a REIT.  Investors benefit from dividend income, cash flow, capital gains, and the diversification offered by a professionally constructed portfolio.

The downsides are also the same.  However, it is uncommon for a mutual fund to purchase properties directly.  Instead, investors have no say in the real estate companies and REITs that the mutual fund purchase shares in.  

Key Differences Between REITs and Mutual Funds

While REITs and mutual funds serve a very similar purpose, there are key differences between the two, including:  

  • Structure:  From a legal standpoint, REITs and mutual funds are structurally different.  REITs must adhere to a strict set of IRS rules that require them to pay out 90% of their taxable income in the form of dividends. Mutual funds have no such requirement.
  • Returns:  Because REITs have to pay out 90% of their taxable income as dividends, their returns consist primarily of these dividends.  In a mutual fund, an investor may receive some dividends, but returns tend to come from slow price appreciation over time.
  • Exchanges:  REITs trade on major stock exchanges, which means they are very liquid and their share price is updated constantly as the market changes.  Mutual funds do not trade on exchanges.  Instead they are offered directly through the fund manager and their price may be updated just one time per day.
  • Investments:  REITs use investor capital to purchase and manage properties directly.  Mutual funds may purchase properties directly, but this is not the norm.  Instead, they tend to purchase shares in a variety of REITs and CRE operators so they do not have direct exposure to properties themselves.
  • Minimum Investment:  Publicly traded REITs do not have a minimum investment requirement, an individual can buy as many shares as they wish.  In a mutual fund, there may be a minimum investment requirement, although it is typically accessible for most individual investors ($3,000 – $5,000). 

One of these investment vehicles is not necessarily better than the other.  But, each investor has their own level of risk tolerance, time horizon, and ability to deal with price volatility.  So, although they can each offer attractive total returns, one may be a better fit for an individual’s preferences.

If neither of these vehicles is a fit, there is a third option…the private equity deal.

What is a Private Equity Firm?

A private equity firm is also a specialized type of investment company that invests in the equity of operating companies, including those that manage real estate assets.  For example, we are a private equity firm that focuses on the acquisition and management of grocery store anchored shopping centers nationwide.

Like REITs, private equity real estate investment capital is deployed into commercial investment properties with the objective of producing passive income for individual investors.  However, unlike REITs and mutual funds, private equity investments are only available to “accredited investors” under rules defined by the securities and exchange commission.

Private equity commercial real estate investments typically come in two flavors, an investment fund or an individually syndicated deal.  From the investor’s perspective, the fund is similar to a REIT in the sense that capital is pooled and used to purchase assets based on decisions made by the management team.  However, the individually syndicated deal structure is somewhat unique to the private equity world.

In an individually syndicated deal, a private equity sponsor raises money to purchase one specific property.  This means that the investor has an opportunity to know exactly what the property looks like, where it is, who the tenants are, and what the market conditions are in the local area.  When matching investor preferences and risk tolerance to the investment opportunity, the individually syndicated deal offers a higher degree of customization.  For this reason, we believe that this is the best real estate investing option for most individuals.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate (CRE) investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, 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 Real Estate Investor  and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or for more information.

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