Like many investors, you may be looking for a way to expand or diversify your investment portfolio. When it comes to real estate, you have a wide range of options. Real estate investment trusts (REITs) are a popular option for investors looking for a less hands-on experience with property management and the potential for steady, passive income.
However, there’s a constant debate among investors about which type of REIT is most beneficial. If you’re new to this alternative investment strategy, we’re here to help you understand the difference between publicly traded and private REITs and identify which one may be more suited to your needs.
What Are Publicly Traded REITs and Private REITs?
Before you can choose between a publicly traded vs. private REIT, it’s important to understand each entity on its own. Here is a summary of both types of REITs.
Publicly Traded REITs
Publicly traded REITs are generally available to all investors, whether the investor is accredited or not. This means investors don’t have to meet specific requirements, such as having a net worth of more than $1 million or an earned income of over $200,000.
These types of REITs are traded on stock exchanges, such as NASDAQ or the New York Stock Exchange. As such, an investor may enjoy more liquidity with the ability to adjust their positions or exit their investments easily. Because these REITs are publicly listed, investors may also have a better indication of the value of their shares.
Publicly traded REITs may be an attractive option for investors who want more flexibility in their investments, such as trading, reallocating, and rebalancing them more frequently. For instance, those who wish to sell their shares within a quick timeline may find that publicly traded REITs are more suitable for their needs.
This may allow investors to maintain a bit more control over their assets than illiquid investments that cannot easily be exchanged for cash without a significant loss in value. Conversely, investors who don’t require the flexibility or have the same liquidity needs may choose private REITs.
With all REITs, investors receive passive income when the trust’s income is dispersed in the form of dividends to all shareholders. Publicly traded REITs are regulated by the Securities and Exchange Commission (SEC), which ensures the company or entity complies with registration and report filing requirements.
Within the publicly traded REIT category, there are two other classifications — Equity and Mortgage REITs. Equity REITs buy and manage real estate properties and collect payments from tenants. Mortgage REITs own residential or commercial mortgages, or debt, rather than physical real estate. Mortgage REIT earnings come from the net interest margin, which is the spread between the interest they earn on mortgage loans and the cost of funding these loans. As a result, Mortgage REITs can be particularly sensitive to interest rate increases.
Private REITs
Private REITs are mainly sold to institutional or accredited investors. To qualify for this investment, investors must meet a certain income or net worth threshold requirement.
Here is a basic overview of some of the suitability requirements you must meet to qualify for some private REITs:
- Individual income: You earned income that exceeded $200,000 in each of the prior two years and reasonably expect the same for the current year.
- Joint income: You and your spouse earned combined income that exceeded $300,000 in each of the prior two years and reasonably expect the same for the current year.
- Net worth: You have a net worth of over $1 million, either alone or together with your spouse, excluding the value of your primary residence.
- Qualified purchaser: You are a natural person — including any person who holds a joint, community property, or other similar shared ownership interest in an issuer that is accepted under Title 15 U.S.C. Chapter 2D, Sub Chapter I, with that individual’s qualified purchaser spouse — who owns a minimum of $5 million in investments.
- Other: You are an accredited investor as defined in Rule 501 of Regulation D for other reasons, such as a director, executive officer, general partner of the Issuer, or FINRA member.
Private REITs are not traded on national securities exchanges or regulated by the SEC, so investors need to do their own due diligence before investing. Private REITs are also not required to file regular reports. Unlike publicly traded REITs, private REITs are typically valued on a monthly or quarterly basis instead of daily, and they are less liquid than publicly traded REITs.
Because investors cannot publicly see share value on a national exchange, it may be more challenging to determine their shares’ worth or evaluate REIT performance at any given moment. However, this also means investors don’t have to worry about daily fluctuations caused by other investors trading in and trading out as with publicly traded REITs. Additionally, private REITs calculate share prices much less frequently, which also contributes to less fluctuation.
Unlike publicly traded REITs, private REITs may borrow to pay dividend distributions, which adds to investor risk. Private REITs, though, may pay higher dividend yields than publicly traded REITs.
Comparing Publicly Traded vs. Private REITs
Because your individual investment needs and financial goals are unique, it’s critical to understand that each investing strategy has potential benefits and drawbacks. To help you make an informed decision, look at both REIT types and compare them across many different factors.
Tax Advantages
REITs are a commonly used strategy for their tax advantages. Both publicly traded and private REITs must distribute at least 90% of their earnings to shareholders, and it avoids paying corporate income tax on the distributions. This tax advantage trickles down to investors, whose dividends are not double-taxed.
Private REITs, which are generally also LLCs, offer a unique benefit. The depreciation from the REIT can be passed to individual shareholders so investors can offset their income with the depreciation tax deduction. Private REIT tax advantages may also include long-term capital gains if investors hold an asset for a certain period.
Liquidity
If you always want the option to sell your asset or cash out of your investment and access your funds, publicly traded REITs may be a better choice. Unlike publicly traded REITs, private REITs are limited by internal cash flow, and many have lock-up periods. This means you may not be able to access your funds for years at a time, until the predetermined exit period.
Investors who have a broader investment time horizon may enjoy the other benefits of private REITs, such as higher returns, and not care as much about their illiquidity. Investors who think they may need to liquidate in the short term but still want to diversify their investment portfolios may be more interested in publicly traded REITs.
Value and Volatility
When it comes to getting the most for your money, private REITs may have the advantage in particular situations. Those who invest in publicly traded REITs are not actually buying real estate — it’s more like they are buying shares of stock. Because the stock market is open to high highs and low lows, there are certainly times when this can work in your favor with a publicly traded REIT. With private REITs, however, there is less volatility with pricing.
Volatility is how much an asset’s price changes compared to the mean price. These changes in price can happen for various underlying reasons. Public markets, by nature, can be highly volatile since several factors influence an asset’s price, including the ability for investors to freely trade due to those price fluctuations.
In some cases, if an investor sells their asset, it can be extremely challenging to recover realized losses and earn new returns after a period of high volatility and impact by market sentiment. With publicly traded REITs, investors can essentially buy and sell on a whim, which means the value of the shares may not be as stable. The value of a private REIT, alternatively, may be more stable because they are valued less frequently by the trust. However, this can be a risk on its own, as the actual share value that someone is willing to pay may be different from what the trust claims it is worth.
Returns
The two most common return categories in real estate investments are yield and appreciation. If you pay $50,000 for your investment and receive $5,000 a year, you’re getting a 10% yield. Publicly traded REITs can be priced high or low based on market conditions, investor sentiment, interest rates and the underlying fundamentals of REITs, and these factors can directly impact the yield. However, publicly traded REITs also generally have higher operational costs, which may affect the yields more than private REITs.
Leverage
Investors are always looking for a healthy balance between risk and high returns. This leverage is part of the strategy and a major consideration for the risk tolerance of every investor. Some publicly traded REITs may be more highly leveraged because they have access to debt from sources outside of traditional banks, such as hedge funds and repossessions. Other publicly traded REITs maintain more conservative levels of leverage.
Some private REITs, however, tend to rely more heavily on secured borrowings, enabling higher degrees of leverage. If your risk tolerance is low, you may find that publicly traded REITs are suitable for you. If your risk tolerance is a bit higher and you have the means, a private REIT could be the right amount of leverage you desire.
Transparency
In a passive real estate investment like publicly traded and private REITs, you may not always have the benefit of knowing exactly what is being purchased. In some cases, a REIT may acquire hundreds or thousands of assets, so getting up-to-date information on all assets to every shareholder isn’t immediate. Publicly traded REITs are more readily accessible.
However, when it comes to share value transparency, investors also have to consider what they are willing to pay versus what the actual value is. Since share prices are quoted similarly to stocks, there may be a discrepancy between share prices and the actual REIT value on the public market. You can calculate the actual value dividing the share price by the REIT’s annual earnings or considering a REITs forward earnings — as you would with any public company.
Risks
Despite the differences between the two REIT structures, all investment involves risks that need to be considered and managed appropriately. REITs are no exception to this as they pose certain unique risks. For example, publicly traded REITs may offer higher resiliency to fraud risk due to SEC oversight, which means reporting, compliance, and accuracy are generally enforced.
Though both publicly traded and private REITs are subject to the same real estate market forces, publicly traded REITs may amplify this risk if they trade above their actual real estate value. In a frothy real estate market, private REITs may be better at having valuations that are closer to the market. However, during downturns, some private REITs can overstate values to prop up share prices or be delayed in re-pricing. In general, private REITs lack the transparency that you see in a public REIT registered with the SEC.
Other types of risks are possible for both REITs, including operational, geographic, and leverage risks. Ultimately, the level of risk varies by each individual offering, so it’s important to do your due diligence before investing.
Contact 1031 Crowdfunding to Learn More About REITs
Investing in REITs brings many potential benefits. Depending on your financial situation and investing goals, you may find that a publicly traded or private REIT is better for you. At 1031 Crowdfunding, it’s our goal to help investors like you make an informed decision when diversifying your portfolio with new investments.
Our extensive online marketplace makes it easy for you to see vetted real estate offerings that may suit your needs. Our experienced team of professionals can also support and guide you as you navigate other alternative investments. If you’re interested in investing in a REIT but aren’t quite sure where to start, 1031 Crowdfunding can help you understand your options. Learn more on our REIT blog page, or contact us today if you have questions.
This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.
