Private REITs Compared to the Public Real Estate Investment Trust
The Higher Yields Carry Some Drawbacks
A REIT, Real Estate Investment Trust, is a little like a mutual fund, but instead, it invests in the ownership of income properties or mortgage instruments. It is a passive way to invest in real estate. You buy and sell shares in a REIT as you do in a mutual fund. You also rely on a management team to buy and sell properties and handle their management.
Equity REITs purchase properties for income in the multi-family and commercial real estate sectors to include:
- office suites
- shopping malls
- strip centers
- medical suites
- other concentrated commercial rental properties
The REIT management team buys the properties and manages them for income. As a shareholder, you receive 90% of REIT profits as dividends based on your proportional ownership. Historically, equity REITs have performed relatively well. Again, it's a passive way to invest in ownership of commercial properties. Advantages of this type of REIT can include:
- participation in value appreciation over time
- rising rents with stable mortgages increase profits and dividends
- profits through short-term purchase and sale of properties
There are risks in all investments, but generally, these REITs have provided reasonable returns at acceptable risk levels.
Mortgage REITs invest in mortgages on real property. Generally, a mortgage REIT will carry a higher risk due to interest rate fluctuations. Rising interest rates can damage returns, and prices of these REITs are generally more volatile. It makes trading in these REITs more of a shorter term strategy than equity REITs.
There are valid reasons for choosing one or the other or even diversifying with both. However, REITs, as stated, are passive investments. You are reliant on a management team's expertise and market calls. Of course, nobody can predict economic swings and the cyclical nature of the real estate market. Also, there can be differences in performance of residential versus commercial REITs. And, as with all real estate, local is important, and some markets do better than others.
Different markets across the country collapsed at different times during the mortgage and housing crash that began in late 2006. Similarly, markets have been recovering at different rates around the country. Real estate has always been and always will be very local in characteristics and performance. Local economic conditions, major employer growth or force reductions and even governmental actions can dramatically impact real estate in an area.
It is true that we expect so-called "experts" and real estate market professionals to have resources and information at their disposal that we do not. However, none of them have a crystal ball, and economies and markets respond to a great many external and local influences, from global to micro-economies. Do as much research as possible on who the REIT managers are and their experience and past performance.
Private REITs, appearing on the real estate investment scene around the year 2000, generally offer higher dividends than public real estate investment trusts. Before jumping into these REITs, know the drawbacks and do your due diligence.
Lack of Liquidity
Generally offered by private financial planners, private REITs are not nearly as liquid as public real estate investment trust shares. One cannot just call their broker and sell their private REIT shares. Also, Private REITs usually have higher investment requirements, so small investors do not normally get to participate.
Higher Sale Commissions
Private REITs generally carry a higher sale commission to the seller, so fewer dollars make it into the investment. Conflicts of interest can be present for this reason, as sellers could want the REIT to grow to increase their profits.
Before jumping into a private real estate investment trust, be sure to look carefully at the prospectus and every facet of how it's managed, dividends distributed and costs/fees. Costs and fees are major drivers of the purchase and sale decisions, as they can help or hurt the ROI significantly. You can do well in the right Private REIT, but that's the trick. Which are "right?" Because they're not very liquid, you can get trapped in an investment when you'd like to exit. Sometimes it's not for long, but you can lose money during that time, or you may have to sell cheap to get out.