REIT ETFs vs. Private REITs – Exploring Your Real Estate Investment Options

Real Estate Investment Trusts (REITs) are companies that own and manage income-generating real estate, such as commercial and residential properties, office buildings, apartment complexes, hospitals, and hotels.

REITs can be an attractive investment vehicle due to their potential to deliver higher dividend returns. One reason for this is they are required to distribute at least 90% of their taxable income to shareholders as dividends.

REIT exchange traded funds (ETFs) and private REITs are two investment vehicles that investors can choose from when building a REIT portfolio. REIT ETFs are highly liquid, allowing investors to buy and sell shares on public exchanges, while private REITs are generally less liquid and often require longer holding periods. While REIT ETF share prices can be highly sensitive to daily stock market fluctuations, private REITs are generally less affected by stock market volatility. However, private REITs are still influenced by real estate market cycles, interest rate risks, and property-specific factors.

In this article, we will explore the differences between REIT ETFs and private REITs and how investing in either vehicle can affect your overall strategy. 

What is a REIT ETF?

A real estate investment trust exchange-traded fund (REIT ETF) is an investment fund that invests the majority of its assets in REITs. Like REITs, REIT ETFs offer real estate investors a stable stream of dividend income without the hassles of property management.

REITs finance, own, and manage the properties, and the ETF invests in different REITs. As a REIT ETF investor, you buy shares that give you exposure to income generated by the properties owned by the underlying REITs in the fund.

REIT ETF shares are traded on public stock exchanges, where anyone can easily buy and sell them on trading days. Moreover, these funds are registered and regulated by the Securities and Exchange Commission (SEC), meaning they have to publish their annual reports regularly. This promotes transparency and gives investors access to crucial financial information.

These funds mostly invest in a wide variety of properties, such as healthcare, commercial, and residential, whereas others specialize in specific property types. Investors can choose to invest in a diversified real estate ETF or focus on a particular property, depending on their portfolio risk-return mix.

REIT exchange-traded funds are of two types: active and passive. Passively managed REIT ETF portfolios replicate the performance of a specific REIT index, such as the FTSE NAREIT All Equity REITs Index. This approach gives broad exposure to the real estate market at a lower cost and lower risk. Actively managed REITs take a more aggressive approach by focusing on selective investments to deliver better than overall market returns. They also come with higher management fees and potentially more volatility.

What Are Private REITs?

Private REITs are a type of REIT offered exclusively to accredited and institutional investors, who are individuals who meet certain income and net worth requirements. They also have a minimum investment limit as a starting point, unlike public REITs, which can be invested in as long as you have the money to buy at least one share.

These alternative investment vehicles can carry a higher risk than public REITs for several reasons. 

They are exempt from registration and, therefore, don’t have the same reporting requirements as public REITs or REIT ETFs. They do not disclose their financial reports as often as public REITs, giving investors little availability of performance data and insights to make their investment decisions.

Moreover, as the name suggests, investors cannot purchase and sell private REIT shares in public stock exchanges. This means you cannot liquidate your position if you want the funds in an emergency. On the flip side, this feature allows private REIT investors to avoid daily market price fluctuations in the stock market. Instead, they are typically valued every quarter.

Private REIT investments can be suitable for investors who want to capitalize on investment properties not available to the general public. They also appeal to investors with a long-term investment horizon who want to earn passive income in the form of REIT dividends.

Pros and Cons of REIT ETFs

Investing in REITs can have several advantages, such as:

Pros:

• High liquidity: REIT ETF shares are publicly traded on the stock market, so you can easily liquidate them if you are in urgent need of cash.
  
• Instant diversification: REIT ETFs invest in properties across multiple REITs and sectors. This mitigates the risk associated with a specific REIT or property type while enabling you to benefit from a high-performing market segment or sector.
  
• Low entry barriers: REIT ETFs offer low entry barriers, allowing individuals to invest in the real estate sector without substantial capital or accreditation. Typically, the minimum investment is the cost of a single share, which can vary depending on the specific ETF and its market price. This affordability makes REIT ETFs an attractive option for investors with limited funds or those beginning their journey in real estate investing.

All investments carry some level of risk. Here’s what investors should keep in mind before investing in REIT ETFs:

Cons:

• Subject to stock market volatility: Since REIT ETFs mainly invest in publicly traded REITs, their share price can change daily. REIT ETF share prices are informed by the underlying real estate value; their value can rise or fall due to market sentiment or economic conditions like changes in interest rates.
  
• Less focused on specific sectors or regions: REIT ETFs are designed as “one-size-fits-all” products that provide broad market exposure and diversification. While this standardization reduces the need for individual tailoring, it also means that REIT ETFs may not address specific investor needs or strategies as effectively as private REITs. This can lead to less control over the investment mix and, in some cases, less opportunity for higher returns that might come from targeted private REIT strategies.

Pros and Cons of Private REITs

Investing in private REITs can provide the following benefits:

• Targeted Investment Strategies: Private REITs often focus on specific property sectors, such as commercial, industrial, or residential, which can offer higher investment returns if managed well.
  
• Access to Institutional-Quality Properties: Investors in private REITs and REIT ETFs gain access to high-quality properties that may be otherwise difficult to reach, such as large commercial buildings or luxury real estate.
  
• Lower Correlation to Stock Market Volatility: Private REITs are less affected by the stock market’s daily fluctuations, offering a degree of stability, especially in uncertain economic times.

There are also some potential drawbacks to investing in private REITs:

• Limited Liquidity: Private REIT shares are considered illiquid assets, meaning they cannot be easily converted into cash. Each private REIT operates under its own share redemption program, which may impose restrictions or limitations on how and when investors can cash out their shares.
  
• Restricted to Accredited Investors: Private REITs carry greater risk than REIT ETFs because they lack transparency, oversight by the SEC or other regulatory bodies, and a liquid market. For this reason, private REITs are often only available to accredited investors—limiting access to many potential investors.
  
• Limited Transparency: Depending on the fund’s prospectus and structure, information about its operations and holdings may be less readily available, making it harder for investors to assess its performance.

Key Differences Between REIT ETFs and Private REITs

When deciding between REIT ETFs and private REITs, it’s important to understand the key differences that affect how each investment works. Here are some major factors to consider:

• Liquidity: REIT ETFs offer high liquidity, as they trade on the stock exchange and can be easily bought or sold during trading hours. Private REITs, on the other hand, operate under varying redemption policies that may provide limited liquidity options. Depending on the terms, investors may face restrictions or delays in redeeming their shares.
  
• Accessibility: REIT ETFs are available to the general public, including non-accredited investors. In contrast, private REITs are only offered via prospectus to institutional and accredited investors.
  
• Volatility: REIT ETFs are sensitive to stock market fluctuations, so their share prices are susceptible to market conditions. Private REITs are valued less frequently and are more tied to property values, making them less sensitive to daily stock market movements.
  
• Control: Both REIT ETFs and private REITs can offer varying levels of diversification or specialization depending on their investment strategies. REIT ETFs typically provide broad exposure across multiple property types and market segments, while some private REITs may focus on specific property types or regions. However, the level of control an investor has over individual investment choices depends on the specific REIT’s structure and strategy.
  
• Tax Efficiency: Dividends from both REIT ETFs and private REITs are typically taxed as ordinary income. One potential advantage of private REITs is that investors may be able to claim deductions for depreciation and amortization, which can reduce their overall taxable income. 

Find the Right Fit for Your Portfolio with 1031 Crowdfunding

The greatest differences between REIT ETFs and private REITs are their liquidity and their risk-to-return profile. You can cash out of a REIT ETF almost any day, but with private REITs, you are locked in for the long haul. When you buy REIT ETF shares, you don’t invest directly in an individual REIT but a basket of publicly traded REITs that give you instant diversification. In contrast, if you qualify to invest in a private REIT, you could partake in an exclusive opportunity to invest in high-quality real estate assets.

When choosing between the two real estate asset classes, you need to consider three key areas: your investment time horizon, risk tolerance, and liquidity needs. 

1031 Crowdfunding’s online marketplace provides a seamless way to explore private REIT offerings and other real estate investment opportunities that align with your unique investment objectives. Our seasoned management team, backed with over 135 years of combined real estate expertise, is ready to guide you through every step of the investment process. 

Register today to create an investor account to discover offerings tailored to your financial goals. Start building a diversified portfolio with high-quality real estate investments!