What is a REIT?
Investopedia describes a REIT as, “a company that owns, operates, or finances income-generating real estate.” REITs are designed similarly to mutual funds. They allow investors to pool their money together and own a share of different commercial real estate properties. The rental income that the company receives from these properties is later distributed to the investors as dividends.
There are two main types of REITs: public non-traded and publicly traded. Both publicly traded REITs and public non-traded REITS are regulated by the Securities and Exchange Commission (SEC). The SEC sets strict rules on how REITS operate. Here are some of the rules that REITs are regulated by, that investors should know about:
- Invest at least 75% of total assets in real estate, cash, or U.S. Treasuries
- Derive at least 75% of gross income from rents, interest on mortgages that finance real property, or real estate sales
- Pay a minimum of 90% of taxable income in the form of shareholder dividends each year (Sec.gov)
A publicly traded REIT allows investors to easily liquidate their capital since they can be sold off just as a mutual fund would be. In contrast, a public non-traded REIT is fairly illiquid, making it very difficult for investors to pull out their capital whenever they choose too. The upside is that unlike a publicly traded REIT, non-traded REITs are not subject to market volatility, allowing investors to reap the benefits of real estate’s long term stability.
What is a PERE?
A private equity real estate firm serves a similar purpose to a REIT, but has quite a few key differences. Private equity real estate allows smaller investors to pool together capital in order to purchase larger properties. In this aspect they work similarly to REIT’s, however, private equity firms allow for a more direct investment with added transparency that investors miss out on through a REIT. Some PERE firms operate through a fund while others offer investment opportunities on a deal by deal basis. Nevertheless, a smaller portfolio allows investors to really understand what their capital is invested in.
Private equity groups don't have to follow the strict guidelines set by the SEC for REITs. This allows for a “leaner” investment process. Unlike a REIT, no large board of directors is required, and private equity groups are not required to pay 90% of income to shareholders as dividends. While this can be an advantage of REITS, oftentimes REIT’s promise high-yielding dividends, which are not always paid by property income, but rather by other investors' capital. Since no form of PERE is publicly traded, investors do not need to worry about market volatility affecting their investment, rather it is purely driven by the real estate market.
Making a Decision
When you make the decision to become a passive real estate investor, you will be faced with the decision of investing through a real estate investment trust (REIT) or through a private equity real estate firm (PERE). While REIT’s can be favorable to investors looking for a lower initial investment, investing through a private equity group will allow you to truly understand your investment, avoid the market volatility of a REIT, and take advantage of a leaner, more transparent investment process.