REITs vs. Private Placement Real Estate Investment: How They Differ Based on Your Net Worth
Updated: Nov 4, 2019
Written by CWS Capital Partners, LLC
Sports fans love to debate about the greatest athletes. Who was the better boxer in their prime, Muhammad Ali or Mike Tyson? Was Wayne Gretzky a better hockey player than Gordie Howe? How about golf? Tiger Woods is considered one of the two best of all time, but how does Phil Mickelson measure up?
Each of these athletes reached the pinnacle of their profession. But they all managed to reach the heights of greatness with a style and talent that differed from each other. Ali was the ultimate skilled boxer and, to use his own words, he floated like a butterfly and stung like a bee. Tyson completely assaulted his opponents with brute power.
In life, there is often more than one way to accomplish a goal. Certain methods may work best for one situation but not another. After all, there is a reason that Tiger and Phil carry 14 clubs in their golf bags.
So it is for commercial real estate investment. While some investors may choose to get their hands dirty with direct investment and ownership, many will opt for a route that allows for all the benefits of real estate investment while relying on professional management to set and execute a plan.
Unless you want to take on direct ownership of a property (along with operations, maintenance, phone calls, liability and more), the two primary ways to pursue investment in commercial real estate are through a real estate investment trust (REIT) or a private placement investment in a limited partnership (LP) or fund. While REITs may work for lower-net-worth investors or for use in individual retirement accounts (IRA), private placement real estate investments can provide high-net-worth investors some distinct advantages.
Distinguishing REIT vs. Private Placement Real Estate Investments
A REIT is a public company that trades on a stock exchange, although it may also be traded privately. Private placement investments in commercial real estate are often offered through an LP via individual investments or funds that are led and managed by a professional real estate firm.
It can be seen from the chart below that a REIT can behave very much like a publicly traded financial instrument, as there is correlation. While both a REIT investor and a private LP investor might not receive dividends in a particular period of a bear market and are open to a financial loss.
REITs tend to invest in single sectors—residential, office buildings, warehouses, etc.—whereas private LPs tend to have more flexibility with regard to their asset diversification. Importantly, private placement investments are less accessible due to financial qualifications for participation and their limited liquidity.
Let’s take a look at some of the differences in more detail.
Risks Associated with Both REITs and Private Placement Investments
Both types of real estate investment vehicles, whether through a REIT or a private placement investment, have their share of risks. Real estate investments may be susceptible to adverse market conditions, underperforming assets, and rely on management’s ability to improve the operating performance at the properties. The property performance is subject to economic conditions, fluctuating interest rates, credit conditions, supply and demand, financial resources of tenants, and availability of financing. Using leverage to purchase real estate property increases the volatility on the rate of return on investment with a majority of real estate investments today using leverage to acquire properties or assets. By the SEC and industry at large, REITs are generally considered a “moderate” risk investment whereas private investments are considered a “high risk” investment.
REITs vs. Private Investment: Which Is Right for Whom?
REITs and private placement investment are both suitable methods of providing real estate exposure to investors. With limited access to private placement investments in a real estate partnership, non-accredited investors will no doubt look to REITs to gain access and diversification. In addition, REITs may be more practical for an IRA account, where the tax advantages of private real estate investing are not as applicable.
A private placement LP investment provides greater flexibility for structuring investments. It may offer sophisticated, high-net-worth investors benefits that include the ability to defer and shelter income via depreciation, as well as the use of 1031 exchanges for tax deferral and estate planning. These benefits draw many high-net-worth investors to private investment partnership.