If you have been considering adding commercial real estate to your investment portfolio, you have probably come across a common, ongoing debate among investors: whether to invest in private real estate or a public REIT. This post will discuss these two vehicles for investing in commercial real estate: how they are similar, how they differ, and how you can determine which type of real estate investment is best suited to you.
First, though, let’s clarify exactly what we mean by each term.
In the context of commercial investing, when we speak about private real estate we are generally referring to a private real estate fund, in which a team of experts raises capital directly from individual investors, and then uses that capital to purchase, rehab, and either operate or resell commercial properties.
Note: The funds established to raise capital for private real estate deals are also often referred to as private placements.
A Real Estate Investment Trust, or REIT, is a company that owns and operates commercial real estate. Public REITs are traded as mutual funds on stock exchanges, similar to other equities.
Before we dig into the differences between private real estate and public REITs, it is worth pointing out the benefits common to both of these mechanisms for investing in commercial real estate. With either a private real estate fund or a REIT, you as the investor can benefit from:
If you buy and operate a piece of commercial property on your own (or with a small team), you will be exposed to the ongoing downside risks inherent in all pieces of real estate. For example, there is always the potential for a downturn in the specific category of property you own (say, an office building or a retail center). There is also the risk of problems with that particularly piece of property, which could necessitate costly maintenance or upgrades.
By contrast, when you invest in a private real estate fund or a public REIT, you are in effect spreading your investment capital across all of the properties that the fund or REIT owns and operates. This diversification limits your downside risk of issues with any one property in the portfolio.
Investing in commercial real estate through a private find or REIT is also a far more passive way to capitalize on real estate’s potential for income generation and wealth building than buying and operating a property yourself.
Many people view real estate ownership of any kind as a passive investment—particularly if they can hire a property management firm and other specialists to maintain the property they’ve purchased. In reality, though, owning a piece of real estate directly is always an active investment: Even if you outsource the day-to-day operational duties to a third party, you are still ultimately responsible for making all decisions regarding that property. That is an active, not a passive, role.
Finally, it’s worth noting that most individual investors simply cannot afford to purchase large-scale commercial properties themselves. And as research from Black Creek Capital Markets points out, over the 20-year period ending December 2017, commercial real estate outperformed the other major asset classes—such as stocks and cash—as the highest producer of average annual income for investors.
In other words, without the ability to invest in a vehicle such as a private real estate fund, most individual investors—even high-net-worth investors—would not have as much access to the potential upside of commercial real estate ownership.
Now let’s discuss some of the fundamental differences between these two vehicles for investing in commercial real estate.
As that Black Creek research we cited earlier points out, private commercial real estate funds have delivered higher average yearly income to investors than have public REITs over the same two-decade timeframe, as the chart below illustrates.
Another important factor to understand about public REITs is that, because they are traded on the capital markets just like stocks and mutual funds, REITs are more highly correlated to equities than private real estate funds are.
In other words, public REITs can experience more volatility, and could therefore be harmed by a stock-market downturn even if both the broader real estate market and the fundamentals of the specific properties under the REIT’s management are sound.
Private real estate funds can generate both impressive income streams and strong long-term returns through appreciation and equity. Moreover, the best of these private real estate funds pay out frequent distributions to investors, such as every quarter.
But it is important to understand that private real estate is typically not a liquid investment, and you will need to prepare to have your capital locked up for a few years.
With a public REIT, by contrast, you can exit your investment at any time by simply selling your REIT shares.
Because they are traded on the capital markets, public REITs are regulated by the Securities and Exchange Commission and therefore have some unique requirements among commercial real estate entities.
Among these requirements, the SEC states that a public REIT “must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.” The problem here is that, in order to satisfy this government requirement, a REIT’s management team might be forced to distribute capital to shareholders when that money could better serve the interests of the fund and its investors if the managers could instead could hold it and use it later to upgrade existing property in its portfolio or purchase additional property.
In other words, strict government regulations of public REITs often force these entities to act in ways that are counter to their investors’ own long-term interests.
But as a commercial real estate entity not regulated by the SEC, a private real estate fund is not constrained by these types of regulations. As a result, private real estate funds are in some cases better able to act quickly to purchase or rehab properties. Moreover, they are able to base their decisions about distributing funds to investors according to when doing so will make strategic business sense—rather than simply because they are legally required to do so on a pre-established timetable.
If you’d like to learn more about the benefits of investing in a private real estate fund, we invite you to discover The Worcester Fund: the leading fund for Kansas City multifamily real estate, managed by a team of experts that has delivered an annualized 30% ROI to investors over the past decade.
This does not constitute an offer to purchase securities, and that any purchase may be made only through delivery and receipt of a confidential private placement memorandum from the issuer, pursuant to which any potential investor must complete and provide an investor questionnaire, subscription agreement and other things required by the issuer, and are subject to the issuer’s verification of accredited investor status and issuer’s acceptance of the subscription