Commercial real estate assets can offer an excellent investment opportunity. But, institutional grade properties are very expensive and likely out of reach for most individual investors. Fortunately, there are two methods through which investors can still own a fractional share of an institutional grade commercial property and they are the subject of this article.
By reading this article, investors will gain an understanding of what a REIT is and how they compare to another popular fractional ownership option known as a Delaware Statutory Trust (DST). In addition, they will learn about the risks and benefits of each as well as how they compare to the types of private equity investments that we offer.
At First National Realty Partners, we offer fractional investment opportunities through a single deal private equity structure. While there are many similarities between this and the REIT and DST options described in this article, there are also many important differences that may make it a more suitable alternative for some investors. To learn more about our current investment opportunities, click here.
What is a REIT?
A Real Estate Investment Trust (REIT) is a type of company that buys, sells, operates, or finances real estate.REITs can be privately traded, which means that they are only available to accredited investors who meet certain income and net worth requirements. Or, they can be publicly traded, which means that their shares can be bought and sold on major stock exchanges by anyone with a brokerage account.
Because REITs own and operate commercial real estate assets, they tend to specialize in specific property types like office buildings, multifamily apartments, or retail shopping centers. For example, Prologis is a large publicly traded REIT that owns and operates industrial/warehouse properties.
Investors like publicly traded REITs for their liquidity, opportunities for diversification, and steady dividend income. But, the downside is that they have no say in how REIT capital is invested and REIT share prices can be subject to periods of significant volatility.
What is a Delaware Statutory Trust?
A Delaware Statutory Trust is a trust that is set up for the purpose of conducting business. They are formed with private agreements under which real, tangible, or intangible property is “…held, managed, administered, invested, and/or operated.” In a commercial real estate context, it is common for the trust to purchase a large institutional asset so that investors who buy shares of the trust can gain exposure to the underlying real estate.
Delaware Statutory Trusts (DSTs) are particularly popular with investors who are looking to defer capital gains taxes from the previous sale of an investment property. This is because IRS Revenue Ruling 2004-86 established that a DST investment qualifies as “like kind” in a 1031 Exchange. Practically, this means that investors can defer taxes on the profitable sale of a property by investing in a DST in lieu of a replacement property.
Aside from the tax advantages, investors like DSTs because it gives them fractional ownership of an institutional quality asset, provides regular dividends, and does not require any active participation. But, there is some level of diversification risk because the DST owns just one property. In addition, they can be illiquid because they require investors to commit capital for periods of 5-10 years.
REITs vs. DSTs: How Do They Compare?
Because they both offer commercial real estate investments, it makes sense to compare the characteristics of each. NOTE: For REITs, the discussion is limited to publicly traded REITs that are widely available on stock exchanges.
The minimum investment for a publicly traded REIT is small, whatever it takes to buy just one share. Often it could be less than $100. This is not the case for a DST, which often requires real estate investors to commit a minimum of $25,000 or more per transaction.
Costs & Fees
For a publicly traded REIT, the transaction costs are minor. They may include a small commission fee from the brokerage to place and other small fees as charged by the REIT.
The fees for a DST are much higher. They are unique to each individual deal, but may include origination fees, annual management fees, and disposition fees.
Under IRS rules, REITs are required to pay out a significant portion of their taxable income as dividends. This means that they often make investment decisions based on the amount of in place cash flow that a property generates. For example, a REIT may purchase a Class A multifamily apartment building with a high level of occupancy because it produces a significant amount of rental income on day 1.
DSTs require that investors make a long term commitment of 5-10 years. As such, they can afford to take a longer term view on a real estate property and have the luxury of the time necessary to fully implement a strategy and business plan. As a result, DST returns typically consist of some income, but also have the potential for capital gains that are based on the success of the property.
Both a REIT and a DST offer some type of tax benefits, but they are very different.
Under IRS rules, a REIT is not taxed at the entity level as long as they follow a certain set of rules, including paying out 90% of their taxable income as dividends. Instead, the income is “passed through” the REIT and taxed at the investor level. Because there is no double taxation, the overall tax burden is lower. That said, investor’s can’t complete a 1031 exchange into a REIT to defer capital gains taxes, unlike DSTs.
By definition, a DST offers investors the ability to defer taxes on the profitable sale of an investment property under the IRS Revenue Ruling mentioned above. In addition, there isn’t a limit on the number of times this can be done. Theoretically, investors could defer taxes indefinitely through a DST investment, which allows their capital to grow tax free over time.
A public REIT can be bought and sold at will, which means it could be held for as short or as long a period as the investor desires.
DST offerings require a long term commitment, typically a 5-10 year time horizon, during which time an investor is not able to access their capital.
Both REITs and DSTs are considered to be passive investment options, which means that individual investors have no say in the day to day management decisions for the property. These are made by the investment manager.
Given the differences between the two types of investments, it is very important that investors perform their own due diligence, and seek legal advice when necessary, to determine which option is most suitable for their individual investment objectives. But, these aren’t the only ways to obtain fractional ownership of a commercial real estate asset.
REITs vs. DST. vs. Private Equity
At First National Realty Partners, we are a private equity commercial real estate investment firm who focuses on the acquisition and operation of grocery store anchored shopping centers nationwide. We are not a private equity “fund” that raises money for general purposes. Instead, we raise money one deal at a time, which allows investors to perform their own due diligence on the asset prior to committing capital to it. This structure offers both similarities and differences to DSTs and REIT investments.
It is similar in the sense that investor capital is used to purchase real estate assets and investors receive regular dividend income plus some chance for capital appreciation. In addition, a private equity commercial real estate investment offers some tax benefits through the use of depreciation and the ability to pursue tax deferral on a profitable sale.
The biggest differences are legal and structural. REITs and DSTs are both trusts while private equity assets are purchased through limited liability corporations (LLCs). Private equity firms are not required to pay a high percentage of their taxable income as dividends and they are not bound by the same rules that govern DST properties. To that end, private equity deal managers have a bit more leeway to pursue long term investment strategies that have the greatest chance of providing investors with a strong return.
Again, REITs, DSTs, and Private Equity are all viable commercial real estate investing options for those who are interested in fractional ownership. One of these choices is not necessarily better than the other. Instead, investors should consider their own risk tolerance and return objectives and pursue the option that offers the best fit for their unique preferences.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate 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 firstname.lastname@example.org for more information.