REITs vs Real Estate
REITs vs Real Estate Investment Funds: How They Compare
What's the Difference Between an REIT and a Real Estate Investment Fund?
The main difference between REIT’s & Real Estate Investment Funds is the type of ownership and how they reward the investor; REITs function like a stock, bought and sold on a public exchange, and reward the investor with dividends. Real Estate Investment Funds reward the investor through property appreciation. Real estate investment funds, particularly private equity in profitable niches, offer greater risk and reward potential for investors than the more typically stable, yet modest-performance of REITs. Real estate investment funds generally have less immediate liquidity and require a more long term investment approach.
Both REITs and Real Estate Funds Allow Entry into a Wide Range of Real Estate Markets
Possible residential real estate investment opportunities include:
- Developing land from scratch
- Renovating to resell,
- Single-family homes
- Apartment-living
- Townhouses and condos.
On the commercial side, we have a wide range of properties with multiple sub-sections. Some of the mainstream ones are:
- Offices
- Warehouses
- Hotels & Hospitality
- Medical & Healthcare Premises
- Light industrial
- Heavy industrial
- Mixed-use.
What Are Examples of REITs?
A REIT gives an investor a bite of the real estate investment apple, without any control of the underlying interests, similar to a NASDAQ stock investor. Investors buy equity in the REIT which, in turn, manages income-generating properties or/and loan arrangements. Indeed, today's REIT conversation extends to almost every real estate and funding vertical you can imagine. Perhaps multi-family attracts you - there are REITs for that. Maybe self-storage or condo rentals take your fancy? There are competing REITS entrenched in those activities, and lots more. The REIT scenario has matured to the advanced stage of mutual fund configurations that zone in on a broad range of investment definitions (including indexes).
There Are Three General REIT Types
An investor in NASDAQ or NYSE industrial stocks like Apple (i.e., APPL) or an S&P 500 index fund acquires an interest in the company/fund without controlling the underlying assets. The same principle applies to REITs and REIT Mutual funds, with investors buying equity in the company or association that, in turn, manages income-generating properties or/and loan arrangements. Indeed, today's REIT conversation extends to almost every real estate and funding vertical you can imagine. Perhaps multi-family attracts you - there are REITs for that. Maybe self-storage or condo rentals take your fancy? There are competing REITS entrenched in those activities, and lots more. The REIT scenario has matured to the advanced stage of mutual fund configurations that zone in on a broad range of investment definitions (including indexes).
The three general REIT types are:
- Equity REITs invest in physical real estate assets. These cover residential, mixed-use, and commercial niches structured to earn rental income.
- Mortgage REITs invest in real estate mortgages and loan instruments. These facilitate property transactions that generate interest income, raising fees and foreclosure profits from loan defaults.
- Hybrid REITS participate in both (a) and (b) above - relying on interest and rental revenue streams.
What Is A Real Estate Investment Fund?
A real estate investment fund is essentially a partnership established to raise funds for in defined real estate projects. Real estate funds are attractive to investors who wish to enter the real estate market without the hands-on management necessary with direct ownership. Usually the project sponsors have specific expertise in a real estate niche, attracting investor interest. There are significant tax advantages available to equity partners, aside from returns that are generally higher than the dividend streams offered by REITs.
In this type of partnership, investors place considerable trust in both the sponsors’ integrity and caliber; so it’s critical for investors to do their due diligence. Project sponsors should have an outstanding track record. Liquidity may be an issue because the equity isn't a publicly traded entity. The equity structure often falls under Reg. 506 B, C, or D.
The general partners orchestrating operations aren’t strictly regulated; they have substantial operational flexibility (versus REITs) when reinvesting and/or distributing profits. However, the outsized profit potentials are very attractive compared to modest-performing REITs.
It boils down to this: The passive partner mindset should focus upon (a) patience and (b) readiness to fill in should cash flow stresses occur. If so, sacrificing REIT-type advantages to yield outsized returns may be worthwhile.
3 Major Types of Real Estate Funds
Real estate investment funds can be structured in many ways. Some funds are open to the masses, whereas others are only available to accredited investors. Funds can focus on specific geographies, asset classes, asset types and more. Most real estate investment funds are closed-end funds that target risk-adjusted passive returns for their investors.
Real Estate Private Equity Fund (REPE)
According to the Commercial Real Estate Development Association, a real estate private equity fund is, “... a partnership established to raise equity for ongoing real estate investment. A general partner (GP), henceforth referred to as the sponsor, creates the fund. The sponsor asks investors, known as limited partners (LPs) to invest equity in the partnership.” Invest in Kona, is an example of a high reputable private equity real estate fund exclusively allowing accredited investors entry into the lucrative, luxury real estate market of the Kona Coast of Hawaii.
Real Estate Exchange-Traded Fund
Real estate ETF’s allow investors the opportunity to invest in the real estate market with a fairly small amount of money. It also allows diversification into different subsets of real estate, including a broad range of property types. ETFs hold a group of investments designed to track a chosen index. ETFs do not involve active management and they tend to charge low fees. Like all ETFs, they trade on a stock exchange and can be bought and sold throughout the day, which means they are highly liquid for the investor.
Real Estate Mutual Funds
Real estate mutual funds own shares of entities that develop and own real estate, as well as shares of REITs. Unlike real estate ETFs, most real estate mutual funds are actively managed (akin to other types of mutual funds.) Fund managers select the fund’s holdings based on expected performance for returns. Some real estate mutual funds are designed to track a specific real estate index (similar to ETFs). They are highly liquid as they are traded daily on public exchanges. Real estate mutual funds can be open- or closed-end.
Real Estate Investment Fund vs. REITs: Advantages & Disadvantages
REIT Advantages
- REITs offer dividend payments.
- They are highly regulated.
- REIT oversight requires fund managers to distribute 90% of the income in dividends annually; those whose main investment goal is cash flow benefit from consistent dividend payouts.
- Allows individual investors to engage in large scale projects, even at tiny amounts. For example, if an REIT has 5000 multi-family units, an REIT can offer small-priced fractional units between $1 and $100. It exactly resembles buying shares in any index fund. Investors in a REIT can utilize this system to own fractional units in accumulated portfolios including any type of real estate: apartments, offices, commercial buildings, etc.
- Highly liquid - with such small, fractional units being publicly traded, liquidity for REITs is generally high.
- Transparency - regulators require full REIT transparency and performance history.
REIT Disadvantages
- Many REITs pay as much as 100% of income in dividends to avoid taxes; this limits property appreciation as little to no capital is put back into the properto reserves to buy into new opportunities, growth potential is severely restricted. Conversely, those focused on maximizing cash flow likely view it as a compelling benefit.
- No tax benefits; dividend distribution always falls under regular tax rates, with no special concessions.
Real Estate Investment Fund Advantages
- Real estate investment funds offer entry into potentially lucrative projects that even high-net worth investors wouldn’t have access to or the expertise to venture into.
- Returns - on average, private equity real estate funds offer much higher returns than REITs.
- Real estate investment funds offer a host tax benefits, including:
- As investors, partners can liberally deduct operating overhead expenses, including a depreciation percentage.
- Capital gain taxes (15 to 20% depending on circumstances) are far lower than REIT ordinary income tax rates, especially in states with higher income taxes.
- Under Section 1031 investors can seek tax deferment provisions - an attractive gateway for investors moving dollar receipts after selling one property for a significant gain to a similar one.
- Profits can be reinvested into the property, increasing appreciation, and ultimately, potential financial returns.
- Allows investment into large scale real estate projects that an individual investor would not otherwise have entry into.
- With fewer restrictions, general partners deliver rewards that can substantially outpace the straight dividend policies offered by REITs.
- Transparency - the top private equity fund managers place a premium on transparency with potential investors.
- Diversification - private equity real estate allows investors to expand their portfolios out of traditional stocks and other investment vehicles.
Real Estate Investment Fund Disadvantages
- Generally, real estate investment funds have a much higher minimum investment amount; minimum investment units seldom drop below $50,000. This however, is a relatively small amount for high net worth (HNW) and accredited investors.
- Less liquidity - real estate investment funds are ideal for accredited investors who have the funds to stay the course and be patient for outsized returns. Unlike publicly traded REITs, private equity investing has less liquidity in the short term.
Real Estate Can Be a Lucrative Investment to Diversify Your Portfolio
People like real estate as an investment vehicle - with good reason. It's been a viable and vibrant wealth creator for hundreds of years. The simplest example is owning your home like millions of US families in every county across the country. Today, a broad range of real estate activities include developing land from scratch, renovating to resell, buy-and-flip, and renting. It covers residential categories like single-family, apartment-living, townhouses, and condos. On the other side of the coin, we have commercial properties with multiple sub-sections.
Then there's the funding connection. Many investors are attracted to real estate as a secure asset that attracts liberal loan and mortgage financing. Indeed, leveraging is an inseparable part of the real estate investment process in most cases. It has become specialized, with regional banks as the principal participants and hard lenders getting behind cash-outs, short-term funding, and bridge loans.
REITs vs. Real Estate Investment Funds Offer Different Approaches
REITs and REIT Mutual Funds, in general, are not in it for capital gain. Regulation dictates that a maximum of ten percent of income is available for reinvestment in REIT assets. The rest of it must flow back to the unitholders. Funds are attractive because they converge on the best rental and interest opportunities, generating close to 15% annually. Under professional managers' guidance, this category is an attractive investment preference for many. Liquidity is a prominent feature that adds to its aura.
Private Real Estate Fund ownership is big into capital gains PLUS rental income. Fix-and-flips or rent-and-flip from twelve-month holds or longer are popular investor models. Throw leveraging into the mix (around 70% loan-to-value), and partners can yield 20-30% IRRs (and even higher). When one merges this with tax advantages, PREFs reflect dimensions REITs find challenging to emulate.
Real estate investing is a trade-off of pluses and minuses around different circumstances. REITs tend to outweigh PREFs when it comes to:
- Transparency and a look back at history
- Liquidating one's investment
- Regulations that keep management on the straight and narrow
- Expansive and quickly executed diversification
PREFs outmatch REITs when it comes to:
- Accessing significant tax advantages
- Pursuing the promise of higher returns
- Flexibility and investment agility
- Focusing on capital gain opportunities
They both do pretty well on:
- Diversification
- Professional management at the helm
- Scalability
People can own REITs and PREFs simultaneously. Investors in 506 regulated funds (i.e., a PREF channel) promising extraordinary returns with all the capital gain’s bells and whistles intact have made good money. As long as one exercises caution where caution is due, both types warrant attention, interest, and possibly commitment.
Invest in Kona: A Unique, Private Equity Real Estate Opportunity for Accredited Investors to Enter the Luxury Coastal Market of Kona, Hawaii
Kona Estates at Opihihale is a private equity real estate fund with a proven track record; the sponsors have successfully developed over a billion dollars with of property over the past two decades. This fund is offering exclusive access to the development of luxury homes on oceanfront property in one of Hawaii’s most desirable locations; the real estate of the Kona coast. This fund offers all the advantages of a general management partnership; the team has elite expertise in both luxury property development and management.
While many accredited investor opportunities require a minimum investment of $250,000 or higher, this fund requires a minimum investment of just $100,000, with no upper limit on the number of units acquired. Managing partners can't draw benefits until the distributions have paid your capital back entirely.
The Kona Development Partners team projects a 22% IRR, excluding the tax benefits accredited investors under a Section 506 C arrangement. And for risk management, the project in early stages is completely debt free, eliminating the liquidity risks associated with many real estate development funds.
If you would like to schedule an exclusive, one-on-one meeting with our sponsors, contact us.