REITs vs. Real Estate Funds – Which Is Right for You?

If you’re intrigued by the income-generating potential of real estate, but you aren’t quite ready for the responsibilities of operating your own properties, then you might be interested in Real Estate Investment Trusts (REITs) and real estate funds. Both offer investors a way to invest passively in real estate, even if they don’t have the experience or capital levels to buy and operate a rental property themselves.

There are some key differences between the two which are important to understand before getting started. It also pays to understand the benefits and drawbacks of each so that you can make the investment decision that is best for you.

Public REITs

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance property. They are required to distribute, typically monthly or quarterly, at least 90% of their taxable income as dividends to shareholders. Investors buy shares either privately or through public stock exchanges. REITs make real estate a viable option for many investors, allowing enjoyment of regular dividends and portfolio diversification without the need for large amounts of capital.

Publicly traded REITs can be bought and sold on the stock market, just like stocks. Because they are registered with the Securities and Exchange Commission (SEC), they are subject to certain financial regulations, and their financial information is publicly available. REIT investors may not actually know the details of specific transactions in which the REIT invests, which can be of interest to individuals interested in real estate.

Like stocks, public REITs are highly liquid; investors can buy or sell shares as desired. By the same token, share prices can be volatile as they are subject to fluctuations in the stock market.

Availability

While the share price of public REITs varies, investors usually have the option of buying as many or as few shares as they like, making public REITs highly accessible to all levels of investors.

Returns

The dividend returns on public REITs vary widely as they are linked to how well the REIT’s investments are performing and to the overall economy, as dividends are determined by management based on the available Funds From Operations, or FFO. Investors should consider the REIT’s assets, the asset class in which it invests, and economic conditions before investing.

Tax considerations

Dividends received from public REITs are most commonly taxed at ordinary income rates for individuals. However, certain individual investors may be eligible for a qualified business income deduction on their REIT dividend income through 2025.

Private Real Estate Property Funds

Private funds are generally structured as Limited Liability Companies (“LLCs”) or partnerships. They cannot be bought on a stock exchange; instead, an investor contributes capital to a partnership or LLC and becomes a direct partner in the real estate fund.

Fund managers will typically focus on one of two strategies when looking to establish a fund, involving either: 1) a value-add fund, whereby the focus is on appreciation of the properties acquired through redevelopment, or 2) a core fund, whereby the fund would invest in stable income-production properties.

Because private real estate funds are not publicly traded, they are not subject to the same financial regulation and disclosure requirements as public REITs, and thus, may appear to be a riskier investment to a potential investor because there might be less oversight of a fund’s transactions. However, it may put an investor at ease to know that many reputable fund sponsors also include annual financial statement audit requirements in their fund documents. In some cases, the fund may be registered as an investment advisor with the SEC, which also requires annual audits. Unlike with REITs, investors (though not the general public) are aware of what the plan is for the assets acquired by the fund and the fund manager provides regular updates to investors on the properties.

Also, unlike REITs, private funds are typically not liquid as your investment is generally locked up until the fund winds down and the assets are sold. The lock-up helps shield investors from the fluctuations in the stock market that may not be correlated to the fluctuations of the underlying real estate owned, making the investment less volatile.

Availability

The majority of private real estate funds are available only to institutional investors. There are also midsize and emerging funds available for accredited and non-accredited investors. Recently, there have been more opportunities for individuals to invest smaller amounts through crowdfunding and other sources (i.e. tokens).

Returns

Investors in a fund receive a preferred return, which is usually negotiated upon investment. Typically, in a value-add fund, investors receive distributions if there is an excess cash flow hold period, but will typically not see large returns on their investments until redevelopment is complete and the properties are sold, usually 3 to 7 years from inception. Core funds typically mimic REITs as the annual cash flow available for distribution is determined by the performance of the fund.

Taxes

Investors in funds are typically taxed at a lower income tax rate for gains generated from sales of the investments and may not owe any taxes on distributions received during the holding period if the investment is generating annual losses due to large depreciation expenses of the real estate. Investors should be aware that they may need to file for an extension on their personal tax returns due to the financial information of the funds’ investments usually not being completed by the initial filing deadlines.

Anchin Can Help

The right real estate investment can be an excellent way for investors to diversify their portfolios and build long-term wealth. That said, any investment should be chosen taking your goals, risk tolerance, and overall financial situation into consideration. If you are investing in a real estate fund, consider ensuring that the legal documents provide for financial statements to be audited by, and tax returns prepared by, a quality accounting firm with deep industry expertise.

If you are considering launching a fund, visit our emerging manager platform landing page here: https://www.anchin.com/services/emerging-manager-platform/  

For more information about private real estate funds, please contact Erica Cohen, or your Anchin Relationship Partner.